By its nature, a transaction involving the gifting of real property to a charitable organization is highly technical. It requires the expertise and cooperation of a number of participants with specialized knowledge—not unlike any complex real property transaction.
As with all transactions, it is important to “get it right.” Errors involving the contribution can easily destroy the intent and benefits of the transaction itself. In some cases, there is simply no middle ground—for tax purposes, the transaction either qualifies or fails to qualify for the intended purpose of providing a charitable tax deduction. Therefore, the transaction needs to be carefully structured and technically correct. This always requires the specialized contributions and cooperation of the professionals involved in the transaction. Generally, these professionals include a real estate lawyer, a tax lawyer or a tax accountant, and a real estate appraiser. Further, if the gift is of an equity interest (such as stock, partnership or LLC interest), as opposed to the real property itself, a corporate transaction lawyer’s involvement may be required. Of course, there may be ancillary parties to the transaction required as well, such as a title company, surveyor, environmental consultant, etc.
II. Transaction Objectives
As is always the case, the objectives of the transaction need to match and conform to the objectives of the parties:
(a) From the perspective of the Donor (the contributor of the asset), the objectives generally involve the conveyance and gifting of owned real property (or the equity interest that owns the real property) to a charitable or similar organization that affords the owner a charitable tax deduction. In some instances, this may involve and include retained interests such as easement rights, leasehold rights, property restrictions, etc.
(b) From the perspective of the Donee (the charitable recipient) (i) the transaction always involves the acknowledgment of the receipt of the real property or equity interest, (ii) the assets conveyed must be of a nature and value so that the transaction and the receipt of the gifted property are consistent with the fundraising or other objectives of the Donee, and (iii) the Donee must be in a position and have the staff and ability to accept, manage and operate (if required) the property and perhaps, at some point, sell or otherwise liquidate the property.
(c) From the perspective of the appraiser, the transaction will require the preparation and delivery of an appraisal that must satisfy the IRS reporting and appraisal requirements necessary to provide the contributor of the interest with a charitable tax deduction through the determination of the fair market value of the interests conveyed, which may also include personal property (tangible and intangible) related to the contributed real property.
III. Transaction Structure
Not unlike other transactions involving the transfer of real property, the most common structures for the conveyance are through the transfer of (a) the equity interests in the property by and through the conveyance of that interest itself (i.e., the transfer of stock, partnership interests, LLC interests, etc.) or (b) the real property itself by and through a deed transfer and (c) a bill of sale or similar assignment of any contributed personal property. There may also be a requirement for ancillary transfer documents such as contract assignments, leasehold assignments, third-party consents and the like.
As the transaction is essentially an acquisition and disposition of property interests, many of the same concerns that are present in a noncharitable transfer are present in a charitable transfer. Therefore, matters such as the quality of the property being transferred, the status of title, the environmental condition of the property, the costs of maintenance and operation, third-party exposures, etc., may be as relevant in the charitable contribution setting as they are in a garden variety sale of real property.
If the transaction is a conveyance of an equity interest, then the recipient, in this case a charity or similar not-for-profit organization, will most likely require the same kind of protections and undertake the same kind of due diligence that it would undertake in a purchase-andsale transaction. Although, in most cases, the transaction will take the form of an “as-is” transaction with few, if any, indemnities, warranties and representations flowing from the Donor to the charity. Assuming that the property being conveyed to the charity has significant value, the contractual exposure of the Donor to the charitable recipient is significantly limited as compared to a bargain-and-sale transaction where a purchase price and/or other consideration is flowing from a buyer to a seller.
IV. Tax Implications
The tax lawyer and/or the tax accountant will need to closely review and track the transaction to ensure that the Donor receives the benefit of the charitable tax deduction it expects to receive and to which it is entitled. The issues involved with the charitable tax deduction resulting from the gifting of real property can be highly technical and complex and, in many respects, are similar to the issues involved in structuring and supporting any other tax deduction. It is necessary to qualify and quantify the deduction and to strictly conform to the applicable requirements of the Internal Revenue Code and regulations.
The tax lawyer and/or the accountant need to determine the value of the income tax deduction, whether the income of the contributor is sufficient to receive the full deduction in the year of the contribution, whether the deduction can be carried forward or backward to other years and, of course, the preparation and filing with the taxing authorities of the necessary tax and governmental return(s) and related forms.
The appraisal required by the applicable provisions of the Internal Revenue Code and Treasury Regulations is highly technical and requires strict adherence to the appraisal requirements. The appraisal is required to support the value of the property being contributed or the equity interest or the real property interest, as the case may be.
The appraiser needs to be a qualified appraiser pursuant to the applicable regulations, and the appraisal must, of course, satisfy these regulations as well. The appraiser must be thoroughly trained in the application of appraisal principles and theory. The appraisal must contain a complete description of the property and include the physical features, condition and dimensions of the property. The appraisal should also indicate the use to which the property is put, zoning and permitted uses as well as its potential use for higher and better uses. Retained rights of the contributing party as well as imposed restrictions on the use, sale or other aspects of the transaction and/or property will affect, and may decrease, the fair market value appraisal.
The methodology used by the appraiser in determining the fair market value of the real property interests, (or the equity interests, as the case may be) includes substantially the same tests that are present in connection with real estate appraisals in general: (a) Comparable Sales, (b) Capitalization of Income, and (c) Replacement Costs. The objective, of course, is to determine the fair market value of the interest being contributed, which is essentially the value that a willing buyer would pay to a willing seller for the gifted interests after consideration of all relevant factors.
VI. Practice Tips/Helpful Provisions
Most charitable and other not-for-profit organizations have their own forms of Donation Agreements and related transaction documents. However, it is highly desirable for counsel for the donating party to prepare the first draft of the transaction documents. Many of these documents are similar, and in some respects identical, to the agreements and forms employed in a noncharitable purchase and sale transaction between unrelated parties. The primary differences among these charitable gift forms and the more customary purchase and sale agreements are that there is no consideration (assuming it is not a “bargain sale transaction”) flowing to the contributing party by the charity, plus there are various specialized provisions to reflect the charitable nature of the transaction and the protection of the desired tax deduction. The specialized provisions are worth noting and include the following:
(a) IRS Determination Letter – As part of the due diligence process, counsel for the contributing party must confirm that the Donee is a recognized charitable or related exempt organization that can provide the required and desired tax deduction as evidenced by an IRS Determination Letter. In addition, counsel for the Donor should confirm that the IRS Determination Letter is current and in “good standing” as of the date of the closing of the transaction, i.e., the effective date of the gift. This can be accomplished through a direct review of the IRS Publications and supported in the Donation Agreement by the Donee’s warranties and representations. Current status can be ascertained using this link. The search is best accomplished using the Donee’s EIN.
(b) Disclaimer as to the Condition of the Property – Whether the transaction is an equity or asset transaction, the Agreement should make it clear that the assets are being transferred on an “as-is” basis with only the minimum of carveouts (title, environmental, authority to convey, etc.) and those carveouts should be on a knowledge basis.
(d) Acknowledgement Letter – For the purposes of the Donor being able to support and evidence the contribution of the property, the Donee should execute and deliver to the Donor an Acceptance Letter acknowledging receipt of the gift of the property.
(d) Donee’s Warranties and Representations – The Donee should provide to the Donor in the Agreement warranties and representations in connection with the Donee’s IRS exemption, in addition to the standard acknowledgments as to its investigation and acceptance of the “as-is” condition of the property subject to the gift.
(e) IRS Form 8283 – The Donor will be required to complete and file IRS Form 8283 (with its Federal Income Tax Return), which must be signed and completed, in part, by the Donor, Donee and the Appraiser.
Details Matter: Error Costs Taxpayer $19.2 Million Deduction
A millionaire real estate developer donated real property worth $19.2 million to a charity without seeking proper advice. He failed to properly substantiate the gift that cost him the tax deduction. He completed the IRS Form 8283 without reading the instructions. Instead of seeking an independent appraisal, he appraised the properties himself, a violation of the regulations. Then he failed to sign the Declaration of Appraisal since the donor is prohibited from doing so. Despite that huge clue, he still did not read the instructions. The IRS was not at all sympathetic. No word on whether the charity noticed the missing signature or obtained a copy of the appraisal before it acknowledged the gift. While charities should not act as tax counsel for a donor, there is a certain amount of diligence that should be done before accepting a gift and acknowledging it.
(f) Future Restrictions – Counsel for the Donor should consider including in the Donation Agreement various restrictions in connection with the property, keeping in mind that restrictions may have the effect of decreasing the fair market value of the property and thus lowering the desired tax deduction. These restrictions may involve and/or restrict future use and/or other rights with respect to the property including “naming rights” limitations. These restrictions may also include a “no-sale” provision for a limited period of time.
(g) Further Assurances – In the event of an audit by the IRS, the cooperation of the Donee may be required and, in all events, helpful. Therefore, the Agreement should contain clear and strong “Further Assurance” and “Cooperation” clauses requiring the future cooperation of the Donee.
(h) The Deed – In most instances, the Real Property deed in an asset transfer transaction is either a Quitclaim Deed or a Limited or Special Warranty Deed (as opposed to a General Warranty Deed).
(i) Operation Issues – The Donee may not have qualified persons in place to manage the contributed assets and become involved in the decision-making process prior to and after the closing. With respect to these matters, it can be helpful to have both the Donor and the Donee appoint in the Donation Agreement representative individuals within each organization to manage and resolve these issues.
The above is a summary of some, but not all, of the more basic issues and requirements involving gifts of real property interests for charitable purposes. Transactions of this kind should be considered where the circumstances justify gifts of this nature, keeping in mind that the transactions can be highly technical, but can be accomplished if properly structured, documented and implemented.