more recently than 10 years before its donation ( disqualified persons include substantial contributors to the foundation ; foundation managers ; people who own more than 20 % of the interest in an organization that contributes substantially to the foundation ; certain family members of any of these parties ; and organizations in which any of these parties hold , directly or indirectly , more than a 35 % interest ).
In these cases , real estate donations with mortgages would be deemed by the Internal Revenue Service a “ bargain sale ” of the property to the foundation ( because it ’ s deemed sold for the amount of debt relief ). The penalty for which a disqualified person would be personally liable will be 10 % of the fair market value of the entire property ( not 10 % of the debt relief ).
Donors also should take pains to avoid “ pre-arranged sales ,” which would occur if they were to negotiate the terms of a sale of property , donate the property to their foundation , and subsequently compel the foundation to consummate the sale . From the IRS ’ s point of view , the existence of a binding commitment to complete the transaction may indicate that the foundation is being used to transfer property to the donor ’ s handpicked buyer while the donor also avoids the tax consequences that would ordinarily result from his or her sale of the property .
Cautions For Foundations
Foundations have reasons to be careful as well when taking a donation of real estate , especially in deciding whether property will be used for charitable or investment purposes .
If it ’ s real estate used for charity — perhaps for housing foundation offices or conducting charitable programs , or if the property will be leased to a public charity rent-free or for a nominal sum — then the value of the real estate should be excluded from the asset base upon which the foundation ’ s annual 5 % payout requirement is based . ( The payout requirement is the amount that must be distributed by the end of the foundation ’ s tax year in order to avoid a tax penalty .)
However , if the property is being used
If the property is being used as an investment , to generate rental income for instance , its value will be included in the foundation ’ s asset base to calculate the organization ’ s annual payout .
as an investment , to generate rental income for instance , its value will be included in the foundation ’ s asset base to calculate the organization ’ s annual payout requirement . In its use as an investment , the property needs to be valued using a commonly accepted appraisal methodology . Instead of appraising the property annually , the foundation may opt to obtain a certified independent appraisal , which can stand for up to five years .
Additionally , when property is used for investment purposes , the donor may want to consider whether the foundation has sufficient cash flow and liquid assets to satisfy the increased payout it will need to make if it holds onto the property . Another possibility is that the property is first donated for investment purposes and then later converted to a charitable use ; in this case , the fair market value of the property at the time of conversion would be treated as a qualifying distribution and would then cease to be included in the foundation ’ s asset base when calculating the 5 % payout requirement .
The foundation should also consider whether the property itself could readily be sold to a third party for necessary cash , understanding that the property couldn ’ t be sold to a disqualified person — which would mean a self-dealing violation . If that happened , the sale would have to be rescinded , and the disqualified person could be personally liable for penalties . So the donor should consider whether there are enough eligible parties in the current market to whom the foundation could sell the property if necessary .
The foundation taking on the property must also keep taxes at the state level in mind . If a property is used for a charitable purpose , the foundation may qualify for an exemption from a state ’ s property taxes . If , however , it ’ s used for investment purposes , the foundation may be responsible for property taxes in the state where it ’ s located . Either way , the foundation likely will be required to make ongoing filings there .
After all these things are taken into account , donors and foundations can still find it beneficial to take advantage of real estate donations — if the transfers are done carefully and with forethought . With the right planning , donors can make sure these donations comply with the law and tax rules while also maximizing their charitable deductions .
JEFFREY HASKELL , J . D ., LL . M ., is chief legal officer for Foundation Source , the nation ’ s largest provider of technology , administration and expertise for private foundations and planned giving . Contact him at jhaskell @ foundationsource . com .
SEPTEMBER 2024 | FINANCIAL ADVISOR MAGAZINE | 23