The mythical Phoenix is said to periodically self-combust before rising from the ashes of its own destruction. While perhaps not a perfect analogy to an interesting trend in charitable gift planning, we’ve certainly witnessed the taking flight anew of gifts of appreciated assets since the depths of the Great Recession a decade ago when the Dow Jones Industrial Average closed at 6,547 on March 9, 2009.
Internal Revenue Service data1 now confirms that the greatest impact on philanthropy during the Recession came as a result of reductions in gifts of non-cash assets. Gifts of cash were little impacted in the wake of the investment and real estate market crashes of 2008-2009. See “Cash Gifts,” p. 9, for IRS reports on itemized charitable gifts of cash during the period between 2007 and 2016.
One might look at this chart and think “hmmm ... the Recession in retrospect didn’t seem to have much of an impact on charitable giving ... just a couple of slightly down years followed by a steady upward trend.” If cash were the only source of charitable gifts, that would be a reasonable conclusion. That isn’t, unfortunately, the full picture.
Non-Cash Meltdown
A very different reality emerges when looking at gifts of non-cash property. These can only be described as a disaster.
It’s now clear that gifts of non-cash assets declined by nearly 50 percent between 2007 and 2009, and this category of gifts didn’t fully recover for seven years. These declines were the primary source of reductions in charitable giving during the Recession, and increases in this gift category have been the primary driver of growth in gifts from individuals in recent years. In fact, in 2016, gifts of non-cash assets amounted to more than twice the amount of gifts received by U.S. nonprofits in the form of gifts at death via bequests from wills and other testamentary distributions.
Digging Deeper
We’ve had IRS data for over a year revealing the difference in gifts of cash and non-cash property through 2016. In late March 2019, the IRS released additional detailed information regarding gifts of non-cash assets through the 2016 tax year. This new data allows us to break down the totals in “Non-Cash Gifts,” p. 9, by principal type of non-cash gifts.
“Gifts of Securities,” p. 10, shows that from 2003 forward (2003 is the earliest year for which the IRS has released this data), gifts of securities rose steadily before a dramatic drop of over 50 percent between 2007 and 2009, followed by steady growth every year for seven years, culminating in the highest totals ever reported in 2016.
These trends come as no surprise to those involved in the world of philanthropy who know that securities gift totals are largely tied to investment market fluctuations and that the positive and negative wealth effect driving such gifts could reverse quickly.
A major surprise in the IRS statistics, however, is the remarkable real estate gift roller coaster ride that’s played out in recent years. Note the precipitous decline of 80 percent in the fair market value (FMV) of charitable gifts of real estate listed on Part B of IRS Form 8283 (defined by the IRS as real estate, land and easements) between 2003 and 2011, followed by an 800 percent increase by 2016, more than twice the increase in the reported market value of securities gifts over the same period. (See “Fair Market Value of Real Estate Gifts,” p. 10.) In fact, recent peaks in real estate gifts explain a significant portion of the increase in individual charitable giving during the recent recovery years.
The exact amount of this increase is impossible to determine as there’s no source available to track the amount actually received by charities on the sale of donated property. The amount carried forward to Schedule A in 2016 did, however, reflect a 346 percent increase over the amount claimed on Schedule A in 2010.
In my opinion, a number of factors may underly these trends, and an understanding of these factors should be added to the knowledge base of advisors assisting charitably minded individuals.
First, it’s useful to consider the nature of the Great Recession and the economic trends that helped precipitate it. In three of the five recessions between 1990 and 2008, real estate values have increased or dropped only slightly. Only the recession of 2008 resulted in a significant nationwide decline in real estate prices. Real estate values plummeted more in some parts of the United States, and some areas still haven’t fully recovered. Unlike other recessions, the most recent economic downturn was actually caused to a large extent by the bursting of a real estate bubble driven by loose lending practices, lax enforcement of securities regulations and faulty ratings of mortgage-backed securities.
The extent of the recovery and the record heights achieved in real estate gifts in recent years may also have been driven by a range of other factors rooted in demographic shifts, combined with economic and tax policies that have been implemented over the past 40 years.
For example, Internal Revenue Code Section 401(k) was added as a last-minute addition to the Revenue Act of 1978. Its cousin, the individual retirement account, was created in the Employee Retirement Act of 1974. Over the four decades since that time, trillions of dollars have been contributed to these plans with amounts held by IRAs and other defined contribution retirement plans growing from $3 trillion to $17 trillion between 1995 and 2017.2
From a demographic perspective, the Baby Boomer generation isn’t only one of the largest generations in history, but also, millions of its members are the first to work their entire careers using tax-deferred retirement accounts. Many hold the bulk of their wealth, composed largely of securities portfolios, inside qualified retirement accounts. In most cases, they don’t otherwise own significant amounts of other securities available to donate for charitable purposes.
After their retirement accounts, many Baby Boomers hold the bulk of their wealth in the form of residential and investment real estate.
The oldest Baby Boomers are now 73, and the youngest of the group are turning 55 this year. Many are planning their retirement strategies, and some are looking for ways to simplify their lives, including relieving the burdens of real estate ownership. Some may own second homes they wish to relocate to after disposing of their primary residence or vice versa.
Donating these properties either outright or in the form of a charitable remainder trust or gift annuity that provides them with additional income and reduces their income and/or capital gains taxes can be an attractive way to participate in a funding effort in a significant way, while simultaneously simplifying and/or enhancing their own financial picture.
For the reasons outlined above, I believe that gifts of real property will continue to grow in importance and may, in fact, regularly exceed the amount of estate gifts each year and the percentage of non-cash gifts made in the form of securities. “Combined Securities/Appraised Value of Real Estate Gifts,” p. 11, shows the return in recent years to a ratio of the FMV of donated real estate to securities gifts approaching 50 percent, a level not seen since the early 2000s.
Real Estate Challenges
If, as it appears, we may have returned to a period of more importance for real estate gifts, it may be prudent to revisit a number of practical implications of such gifts that most donors, nonprofits and advisors haven’t regularly encountered for a decade or longer.
Whether one is structuring a gift of real estate, securities or other non-cash properties, a number of fundamental factors must be addressed—valuation, encumbrances, liquidity and ease of transfer.
In the case of publicly traded securities, valuation is relatively straightforward as there are market prices that can be readily consulted to determine value for the purpose of tax deductions or certain other needs such as determining payments from trusts or annuities that are based on value. And, unlike real estate, securities aren’t typically encumbered by liens that take precedence over the rights of any transferee. Liquidity also isn’t a problem, as securities can be sold in well-organized markets and easily transferred in the age of online financial transactions in which most shares are never physically owned or transferred.
Real property is a very different case. It can be a challenge to properly value primary residences, vacation homes, investment properties and other real estate. Comparable sales, capitalization of income and other means are available to provide guideposts, but real estate appraisals are an inexact science at best.
Debt can also be an issue where real estate is concerned and can raise complex tax challenges related to realization of ordinary income and capital gains when a gift is completed using debt-encumbered appreciated real estate. In some cases, such as funding a charitable remainder trust, it isn’t even possible to do so when the transferred real estate is subject to liability for any debt at the time of transfer.
Unlike securities, a charitable donee of real property will typically be in the chain of title, if only briefly, prior to a sale of contributed property. Because of potential liability related to debt, environmental issues, pre-existing tort claims associated with property and other known and/or unknown liabilities, nonprofits are understandably reluctant to take title to real property in some cases.
Given these challenges, one might ask why nonprofits would want to be engaged in encouraging the donation of real property to fund significant gifts. The answer is simple. As Depression Era bank robber Willie Sutton purportedly remarked when asked why he robbed banks, “Because that’s where the money is!”3 the same is true with gifts of real estate. The average appraised FMV of property used to maken15,000 gifts of real estate in 2016 was $2.1 million.4 In comparison, the average size of securities gifts was $92,000.5 As an example of the size and charitable impact of such gifts, a university recently funded the construction of a new building named for a donor. The construction was funded with the proceeds from the $17 million received from the sale of an agricultural property that was donated in the course of a major capital development campaign.
And, such gifts aren’t solely the province of the wealthiest individuals. According to the IRS, over 50 percent of the FMV donated real estate gifts in 2016 were from individuals with adjusted gross incomes (AGIs) of less than $500,000. These properties averaged $375,000 each.6
A Successful Real Estate Gift
As noted above, real estate (and other illiquid assets such as closely held business interests) can present special considerations.
First, focus on ownership and the prospective donor’s right to transfer. Too often, charities and donors travel far down the gift path before determining the exact form of ownership a prospective donor may enjoy and whether the property is subject to debt that must be satisfied prior to a gift.
Next, address the value. Treasury regulations require donors to obtain a qualified appraisal for a gift of property other than cash that’s worth more than $5,000 and isn’t publicly traded ($10,000 in the case of closely held securities). If real property is valued at more than $500,000, the appraisal must be attached to the donor’s tax return. The donor must file Form 8283 at the time of the gift, and the charity must file Form 8282 at the time of a sale within three years of the donation. If the subsequent sale is for an amount the IRS subjectively determines is out of line with the claimed value at the time of donation, the deduction may be challenged in an audit.
When advising clients regarding appraisals of real estate, art and other property that requires a qualified appraisal, it can be helpful to stress test the charitable deduction prior to engaging in the appraisal process.
Most gifts of real estate and other relatively illiquid assets are capital assets that have appreciated in value and will frequently yield deductions that are larger than can be used in one year due to the 30 percent of AGI deduction limit for such gifts.7
Take the case of an individual with an anticipated AGI of $300,000. She would like to donate a home she believes is worth $850,000 for which she and her late husband paid $200,000 some 35 years before. Homes in their area have been selling in the range of $550,000 to $875,000. The home hasn’t been updated in over 25 years, and she’s been advised by a local real estate professional that an appraisal of more than $650,000 isn’t likely.
Before pressing to obtain an appraisal pushing the upper ranges of market realities, the donor and her advisors may want to determine the maximum deduction that can actually be used. In this case, that would be 30 percent of $300,000, or $90,000 for the year of the gift and up to five subsequent tax years. Six times $90,000 amounts to $540,000, the maximum that could be deducted under these assumptions. There’s thus no need to obtain an appraisal for more than that amount. The donor would need an AGI of $475,000 to make use of a deduction based on a $850,000 valuation.
There’s evidence that this factor is significant when valuing gifts for charitable deduction purposes. With gifts of securities, 99 percent of the claimed value of donated property was carried forward to Schedule A in 2016, indicating that donors and advisors are determining the amount of securities gifts to be donated based on what can be deducted in a given year. In the case of real estate, the percentage of the donated amount actually deducted in the year of the gift drops to the 20 percent range on average, indicating that the 5-year carry forward period and 30 percent of AGI limitation may be factoring into the maximum appraisal desired.
Transfer and title issues can be dealt with through various means. In some cases, real estate and other illiquid property charities don’t want to own directly can be donated to a donor-advised fund (DAF) at specialized foundations, the property sold and the proceeds directed to one or more charitable entities with no need for any of them other than the sponsor of the DAF to be included in the chain of title.
It may also be possible to engage in what’s known as a “directed close” transaction, in which the title doesn’t actually transfer to the charity that enjoys the gift proceeds but rather directly to the ultimate purchaser from the charity based on a previously determined option price.8 This technique can also be useful when a realistic and predictable market determined value is desired for gift recognition purposes or on which to base the amount of fixed payments from a trust or annuity when there’s a desire on the part of both the donor and the recipient to know the extent of benefit or risk they may be assuming.
Changes in the “What”
There are five parts to a charitable gift: (1) who makes it, (2) why they make it, (3) what they give, (4) when they give it, and (5) how they structure it. This article has touched on notable changes in “what” has been contributed in recent years and raised a few of the baseline issues that should be considered when setting out to structure gifts that serve to maximize benefits of a rapidly growing category of real estate gifts to all concerned.
Endnotes
1. National estimates for individual giving published by Giving USA each year are largely correlated to amounts reported as deductions for that year by the Internal Revenue Service published at www.irs.gov/statistics. Giving USA has reported that individuals contributed $272.4 billion to charities in 2016. The IRS reported that $234 billion was deducted on income tax returns for that year. This amounts to 86 percent of individual giving reported by Giving USA. For this reason, IRS reports are considered to be among the most reliable indicators of trends in individual giving related to age, percentage of adjusted gross income contributed, type of assets contributed and other factors.
2. Seewww.ici.org/pdf/2018_factbook.pdf, at p. 169.
3. Seewww.investopedia.com/terms/w/willie-sutton-rule.asp.
4. See IRS Statistics of Income, www.irs.gov/statistics.
5. Ibid.
6. Ibid.
7. Internal Revenue Code Section 170(b)(1)(C).
8. Guest v. Commissioner, 77 T.C. 9 (1981); Stark v. Comm’r, 86 T.C. 243 (1986).