Giving real estate is an impactful way to support a charity and provide tax benefits to donors. But it’s rarely a simple transaction. Often it carries thorny restrictions and issues that have to be resolved, AND almost every major gifts officer has a failed gift horror story they can’t shake from their memory.
Most charities, today, won’t even entertain real estate gift inquiry. It’s even written into their gift acceptance policy. While real estate can be a tax optimal asset for a donor, it can be a challenge for charities to accept, whether because of risk tolerance, board policy, or practical concerns with the potential for property management burdens and indeterminate sale date.
Add an encumbrance such as a mortgage, and the risk and tax treatment quickly gets even more complex. Debt reduces both the donor’s tax benefit and the charitable dollars ultimately realized for charity.
When gifting mortgaged real estate, the donor is relieved of the debt while the encumbered value is treated as a sale to the recipient charity. Also different from mortgage-free gifts of real estate, capital gains realized from debt-financed assets are generally taxable as unrelated business income (UBTI) to the charity unless it meets certain exemptions.
Some of these debt-burdened properties can be very good candidates for charitable giving. However, if it has any debt, most nonprofits will regretfully pass on the proposed donation unless the donor is willing to pay off the debt pre-contribution. Is there a way this could work better for all parties?
Yes. The Dechomai Foundation, Inc. has managed such gifts for many donors who have valuable property with debt under 30-40% of the fair market value.
Solution #1: We’ve accepted the donation as a bargain sale, where the purchase price is equivalent to the debt. Then, upon the sale of the property, we calculate our unrelated business income tax, if necessary, and grant the net proceeds based on the donor’s recommendation.
Solution #2: We’ve purchased the portion of the property equivalent to the debt, with the donor then making a charitable donation of the remaining interest. Dechomai, along with the other owner if one exists, would then cooperate in the sales process.
As an example, imagine a $2 million vacation home (with a $500,000 mortgage) that a donor is no longer using and wants to donate. Dechomai could purchase the mortgaged 25% interest in the property for cash, with which the donor pays off the debt. The donor is free to donate the remaining 75% share either to Dechomai or another charity or simply keep some proportional amount. The charity (or charities/donor) then sells the entirety of the debt-free property and receives the proceeds appropriately. This can work well for outright major gifts or life-income gifts (CRTs and CGAs).
Solution #3: A final, higher-risk strategy for mortgaged property is to have the donor simply keep the debt obligation in place. The donor contributes whatever percentage they choose to Dechomai Foundation, and signs a side agreement consenting to continued payment of the mortgage. This is a higher-risk proposition for the charity/donor, since the lender could call the loan under the “due on sale” clause. The donor may prefer this approach, since there is arguably no relief of debt from a tax perspective. Clearly, a donor should seek strong financial, tax and legal counsel to explore this solution.
Bottom line: Charities should consider possible solutions before rejecting mortgaged real estate.
Finding creative solutions to complex donation situations and turning rejected gift inquiries into real dollars for charitable good is what Dechomai does. Dechomai is one of the few organizations in the country who actively engages in donor gifts of real estate. Our 15-person team has completed well over 500 real estate gifts – with debt, without debt, domestic, international, in partnerships/LLCs, retained life estates, as initial trustee on CRTs, for CGAs, etc.
Ready for more? Register for our November webinar:
1) Nov 11, 2020 12:00 PM in Eastern Time (US and Canada)
2) Nov 12, 2020 12:00 PM in Eastern Time