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Monday, May 6, 2024
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Case Studies |
In-Debted to Charity
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Case:
Maria Gonzalez, 80, was a lifelong volunteer of a local homeless shelter. Most of Maria's contributions to the shelter consisted of her time, hard work and passion to help people. She made only modest financial contributions, because her charitable giving goal was to leave a large bequest at her death to the shelter. Her estate was valued at $1.4 million, which was comprised of a $400,000 home, $200,000 IRA and $800,000 of stocks. She desired to leave the stocks to her children at her death. The rest of her estate she wanted to leave to charity. Maria learned that leaving her IRA to charity would avoid income and estate taxes, which pleased her greatly. With respect to her home, Maria wanted the shelter to have it as well. As a result, her attorney suggested giving the remainder interest in her home to the shelter. This gift would provide Maria with an immediate income tax deduction, and the home would pass to the charity without having to go through probate. Moreover, it would allow Maria to live in her home for the rest of her life. However, six years ago, Maria took out a home equity loan to make improvements to her home; thus, she was concerned about the $20,000 remaining mortgage on her home. She had purchased the home for $50,000 about 40 years ago.
Question:
She wonders how this mortgage will affect her deduction, and, more importantly, if this mortgage raises any issues as to the validity of the gift.
Solution:
A mortgage is an important factor in transferring a remainder interest in a home. The safest treatment of the mortgage (but least favorable to the client) was laid out in PLR 9329017. There, the Service stated that the transfer of the mortgage was deemed a bargain sale. Thus, the donor had to realize the full amount of the mortgage and pay gains accordingly. However, the home exclusion may be used to offset the gain. With respect to the charitable deduction, the donor was entitled to a charitable deduction based only upon the equity portion of the home. The Service did go on to state that each payment of principal constituted an additional charitable contribution. Both of these charitable deductions would be measured by the remainder interest value.
In Maria's case, her equity portion in the home was $380,000 ($400,000 - $20,000); therefore, her deduction based on the AFR and Factors from IRS Pub. 1457 would be $238,000. In addition, she will be entitled to a charitable deduction for the value of the remainder interest for each principal payment that she makes. Maria will also have to report gain of $17,500, which represents the difference between her mortgage and her prorated basis ($20,000 - $2,500). However, her charitable deduction will easily offset this gain. Moreover, Maria may elect to use her $250,000 home exclusion. Consequently, Maria agrees to gift the remainder interest in her home to the shelter. Maria feels successful in knowing her lifetime and testamentary gifts to the shelter will provide comfort and relief to others for many years to come.
Editor's Note: There are some commentators who believe the Service's position is erroneous. They argue that, if the donor agrees to hold the charity harmless with respect to the debt, this arrangement should not be treated as a bargain sale. Especially considering the fact that by the time the charity receives the property, it is unlikely there will be any mortgage remaining on the home. Therefore, when determining the charitable deduction, the value of the mortgage should not be taken into account since it will be extinguished while the donor is still alive. In other words, the obligation to pay the mortgage is similar to the obligation to pay maintenance, insurance, and taxes. Unfortunately, this view does not seem to have the approval of the Service or a Tax Court to date. Thus, counsel should proceed with caution.
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