Sweet Spot for S.E.C.’s Consulting Expertise

by Chase V. Magnuson, CCIM

Sweet Spot for S.E.C.’s Consulting Expertise (Summer 2014)

The charitable world is turning its attention to the use of real estate donations to meet its fundraising goals. At every level, S.E.C. consulting services become an important element in these gifting arrangements. Corporations donate surplus property to obtain a large charitable tax deduction. Individuals use several types of arrangements to meet their philanthropic wishes. Currently there are over 1.6 million charities registered under IRS guidelines, and they receive over six billion dollars in real estate equities each year. Over $15 billion in real property offered to the charities is rejected. In most cases the charities pass on the donor’s offer because of concerns for risks that come with ownership of real estate and the uncertainty of the potential value they are receiving. Charities team up with consultants and local real estate agents to manage the process so donations have a higher probability of successful outcomes. The menu of gift options includes the following:

• Outright gift — Never underestimate donors’ capacity to make an outright gift. Don’t start off assuming, for example, that they will want life income as part of the arrangement. The outright gift is the simplest gift for all involved, provides the maximum and earliest financial benefit for the charity, and provides the maximum tax benefit for the donor.

• Part sale, part gift— For donors not wanting to give the property away entirely but wanting some sales proceeds as a lump sum (as opposed to receiving funds in the form of trust payments or annuity payments), there are two structures that can be adapted to fit a wide range of situations:
  • Bargain sale — A property owner selling his or her property to an exempt nonprofit organization at a price below the appraised fair market value of the property is entitled to a charitable deduction for the difference between the sales price and the appraised value. The deduction from this gift portion can often be used to offset the exposure to capital gains tax on the sale portion of the property. A charity contemplating such a transaction will need access to working capital to cover its purchase price and holding costs prior to the time it sells the property (unless simultaneous sales are arranged).
  • Fractional interest sale — A property owner may elect to donate an undivided fractional interest in a property to a charity, at which point the two parties typically cooperate in marketing and selling the property. The donor is entitled to a charitable deduction based on the percentage of ownership he or she donates (sometimes adjusted to reflect the minority discount rule). At the time of sale, net sales proceeds are distributed to the donor and to the charity based on their respective ownership shares. The advantage of this arrangement for the charity is that it doesn’t require upfront capital for purchase.

• Life income arrangements— Depending on the desires of the donor and on the policies and flexibility of the charity, either a Charitable Gift Annuity (CGA) or a Charitable Reminder Unitrust (CRUT) can be used to provide the donor with a combination of a deductible gift and income for life or for a period of years (in the case of a CRUT).
  • Charitable Gift Annuity — Despite today’s low CGA rates, many donors seeking to make a gift of property in exchange for retirement income prefer the CGA solution over the CRUT solution because of the attractiveness of fixed rates and the relative simplicity of the CGA. In response, more and more charities are deciding that they would be willing to fund a CGA with property, provided they can defer payments and adjust the payout rate to reflect their likely actual proceeds from sale, net of expenses.
  • Charitable Remainder Unitrust — A CRUT is established by placing the property in a trust, then selling it to establish an asset on which a fixed percentage is paid to the donor for life. A percentage, typically 5% to 7%, is then paid out to the income beneficiary(s) for their lifetime or for a set number of years.

Motivating factors include:

• Wanting to convert a nonperforming (from a financial point of view) asset into assets that might generate 5% or greater (through a charitable remainder trust, or through a charitable gift annuity) to supplement retirement income;

• Wanting to trigger a big deduction to help offset the large gain coming from the sale of a family business or another property; and/or

• Wanting to make the decision about the property now rather than arguing about it with family members for the next 20 years.

Case Study: Bargain Sale The Charity staff had trained property managers and real estate agents on the benefits of gifting property. The “Bargain Sale” concept is the approach that helped complete the real estate donation described below. The owners of a 40-unit apartment complex contacted a property management firm in Albuquerque requesting to establish a management arrangement. The issues facing the owners and the management firm were the following:

1. A 30% vacancy factor

1. Tenants in various governmental subsidies programs being incompatible with other tenants

1. A history of late rental payments and subsequent court actions

1. Numerous drug arrests involving both the tenants and their guests

1. An existing mortgage of $290,000 being virtually non-assumable or with owners as guarantors

1. Owner’s basis (property acquired via Section #1031 exchange) was $100,000

1. Located in a high crime area

1. Tenants having physically abused property (i.e., car destroyed one corner of a building, and unreported water leaks)

1. Fast additional funding required for the construction project lest all work be stopped (The owners were moving to Mexico to complete a retirement home.)

1. Negative monthly cash flow despite the owners donating their time to management, repairs, apartment leasing, and regular appearances in court on pending eviction litigation

The professional management firm would not accept the assignment. It did, however, arrange for a meeting between the owners and a representative of the Charity. At that meeting, the owners agreed to donate their equity over and above the cash necessary to retire the mortgage and provide funds to complete the construction of their Mexico home. The balance of the property’s value was to be contributed to the Charity. The parties entered into a “Bargain Sale” contract in which the Charity agreed to pay the Donors $500,000. This would allow the Donors to pay off their $290,000 mortgage and have a $210,000 cash balance. During the due diligence period, the Charity found a qualified buyer for the complex. It was the buyer and the Charity who negotiated the terms of the sale. Both transactions closed simultaneously, which allowed the Charity to use the third party’s money to close on its purchase from the original owners. The Donors were released from the mortgage obligation, received $120,000 in cash, took out a second mortgage for $90,000, and made a charitable gift deduction of $500,000 based on the appraisal of $1,000,000. By identifying properties with low basis, philanthropic owners and their professional advisors can craft creative solutions to apparent problem situations; all parties, therefore, benefit from the outcome. Case Study: A Solution to a Prearranged Sale Dilemma A donor approached a fundraising staff member at the George Washington University with an offer to donate her rental condominium. She was excited because it was under contract to sell for $550,000 with closing to take place in 10 days. The university’s real estate specialist met with the donor and discussed the prearranged sale. The donor was advised that the university would be happy to receive the gift, but under the circumstances, the donor would be subject to a huge capital gains tax. (The basis in the property was $50,000.) The donor did not understand why the Charity would not accept the gift and give her full gift credit. The initial gift of the condo was to be the first of two property gifts she would use toward funding a $1 million endowed scholarship. She planned to add the equity in a second property to the pool for the endowed fund. Should the two net equities not equal $1 million, she intended to make up the shortfall with a provision in her will or use cash assets to fulfill the commitment. Losing credit for the first transaction was not an option if the Charity wanted to save this wonderful donation. The team of accountants and attorneys involved in the original property purchase agreement came up with a solution. The donor/seller and buyer agreed to amend the purchase agreement to allow the donor/seller to add a provision for an Internal Revenue Service Section 1031 exchange. Exchanging the equity in the property for another property allowed the donor to freely donate the second property without capital gains taxation. The sale of the condo was completed as planned. The net proceeds from the closing were placed into an escrow account controlled by a facilitating agent. With the expertise of the university’s real estate specialist, a replacement property was located and purchased within the guidelines of IRS 1031 exchange provisions. Once the second property had closed, the donor leased the property for a short period of time and decided to move forward with a bargain sales agreement. This is a simple agreement in which a donor sells securities, real estate, tangible personal property, or other assets to a qualified charity for less than the fair market value. The bargain sale reimbursed the donor for costs related to the property exchange, and the university for funds advanced to repair the replacement property. After the reimbursements were made, the gift was booked at nearly the face value of the original property value when it was first offered as a gift. A buyer was located for the second property, and closing took place. Funds were distributed to each party according to the donation agreement. The professionals who played a role in this type of arrangement included a tax attorney, a certified public accountant, a title company officer, the university’s general counsel, a facilitating agent, and a Realtor with Section 1031 exchange experience. To use this technique, the property offered as the donation must meet the IRS criteria as “like-kind” property. The Starker provision requires that a donor and his/her agent comply with this or use the simultaneous closing technique. S.E.C. members might be well served to use their creative real estate knowledge to help public charities fulfill their missions. It is estimated that more than $65 trillion in assets will be transferred by this generation to the next during the next 25 years. About 40% of this amount is in real estate equities. Seize the day! Chase V. Magnuson has over 40 years of experience in the real estate industry, with an extensive background in facilitating donations of individual, corporate, and commercial investment real estate. He developed marketing material of guidelines for donations of real estate for charities and donors and has conducted training sessions across the country to help others learn how to make gifts of real estate beneficial to each party. In 2014, he coauthored the book The Secret Power Behind Real Estate Donations. Chase is the Director for Planned Giving, Real Estate, at the George Washington University’s Division of Development, and President / CEO of Real Estate for Charities, an organization he founded in 2000 to facilitate donations of real estate to charities. Chase earned a B.S. from Ball State University in Muncie, Indiana. He holds the elite designation of CCIM (Certified Commercial Investment Member), and he is a Certified International Property Specialist (CIPS), a Senior Real Estate Specialist (SRES), and a member of the International Council of Shopping Centers and the Corporate Real Estate Network.

For more information on this subject, please contact:

Chase V. Magnuson, President
Real Estate for Charities
Phone: (714) 815-8889
Email: info@realestateforcharities.com