Friday April 19, 2024

4.7.6 Gift Annuity, Lead Trust and PIF

Gift Annuity, Lead Trust and PIF

Gift Annuity:  A charitable gift annuity (CGA) is an excellent option for donors with appreciated real estate.

Real Estate for a Gift Annuity in California:  Charity ABC has a potential donor who wishes to transfer land in exchange for a charitable gift annuity (CGA).

Charitable Lead Trust:  Real estate can work very well with a charitable lead trust (CLT).

Pooled Income Fund:  Real estate is not generally recommended for a PIF, because of the illiquid nature of real estate.

Gift Annuity
A charitable gift annuity (CGA) is an excellent option for donors with appreciated real estate. A CGA provides a charitable tax deduction and a fixed income stream for life. In addition, a CGA gives a donor two capital gain benefits: 1) partial bypass of the donor's unrealized capital gain and 2) deferral of capital gain taxes on the remaining portion of the donor's unrealized capital gain.

Because of the unmarketable nature and carrying costs associated with real estate, some charities are reluctant to accept real estate in exchange for a CGA. However, there are several ways a charity can minimize its risk. A charity can suggest a deferred CGA instead of an immediate CGA. With a deferred CGA, a charity has a one, two or maybe three-year deferral period to sell the property. More important, a charity's payment obligations do not begin until the deferred date selected. Ideally, a charity will have time to sell the real estate without the immediate pressure of annuity payments to the donor.

A charity can suggest a semi-annual or annual payment frequency. As with the deferred CGA, the hope is that the property can be marketed and sold before the first annuity payment is due.

A charity can suggest a lower CGA payout rate or a lower CGA contract value. The former option is possible only in states that permit a charity to depart from its CGA rate schedule on a case-by-case basis. In any case, it is important that a donor fully understands the reduction and agrees to it.

Example 4.7.6A

Anna Annuity, owns real estate valued at $100,000. There is no debt on the property. She wants to sell the property and reinvest for retirement income. However, she does not want to pay capital gain tax. Therefore, she approaches her favorite charity about a CGA. The charity is very interested in the real estate but has a couple of reservations. First, it is possible the real estate may sell for less than $100,000. Second, the charity would be responsible for property taxes, insurance and maintenance until the property is sold. Finally, the charity knows it will pay closing costs and broker's fees of 5-8% upon sale.

As a result, the charity asks Anna if she will accept an $85,000 CGA in exchange for her real estate. The charity explains that this 15% reduction takes into account the uncertainty of sales price, ongoing holding costs and sales costs. Anna understands the charity's concerns and believes the reduction is fair. Therefore, she agrees to the $85,000 CGA. Pursuant to the CGA agreement, Anna will receive a 5.8% annuity, or $4,930 each year. Based upon the $85,000 contract value, she will receive a $41,214 charitable deduction. In addition, Anna will receive "another" charitable deduction for $15,000, representing the difference between $100,000 (appraised value) and $85,000 (CGA contract value). In effect, Anna is making an outright gift of the excess $15,000. Thus, Anna's total deductions equal $56,214. Remember that a charity's costs to sell property do not reduce a donor's charitable deduction, e.g., broker's fees associated with selling donated stocks do not affect a donor's charitable deduction.

Alternatively, if agreeable to Anna and permissible under state law, charity may suggest a lower annuity rate. For instance, charity suggests a $100,000 CGA but with a 4.93% annuity payout. The annuity payout is still $4,930. (The charity could have suggested an even lower payout.)

Real Estate for a Gift Annuity in California
Will accepting real estate for a California gift annuity require 3.33% withholding by the charity?

Charity ABC has a potential donor who wishes to transfer land in exchange for a charitable gift annuity (CGA). This is a "bargain sale" transaction and the question is whether California's 3.33% withholding requirement on sales of real property (AB 2962) will apply to the portion of the land "sold" to Charity ABC in exchange for the CGA.

There are several exceptions to the 3.33% withholding requirement. A tax-exempt seller or CRT is exempt. This exception does not apply with a real estate gift annuity because the seller is an individual and the buyer is the tax-exempt entity. A second exception is for the sale of a principal residence that qualifies under IRC Sec. 121. With a gift annuity for home or gift annuity for life estate, there is no withholding requirement.

Another exemption from the 3.33% withholding requirement exists where the total sales price of the property is less than $100,000. See this article. If the annuity contract value of the land transferred to Charity ABC is less than $100,000, this exception should apply. If the seller completes and files Form 593-C, no withholding is required.

If the annuity contract value is greater than $100,000 for property other than a principal residence, then the 3.33% withholding would seem to apply. The question then becomes whether the full 3.33% must be withheld at the time of the creation of the gift annuity or if Charity ABC can defer the withholding to coincide with each yearly annuity payment.

There is specific provision in the 3.33% withholding requirement rules for traditional installment sales. Specifically, if the seller in an installment sale files Form 593-I and the buyer agrees to withhold 3.33% of each installment payment, the 3.33% need not be withheld up front. For a brief discussion of this installment sale provision, click here.

While transfer of land to Charity ABC in exchange for a CGA is similar to an installment sale because the seller/donor receives an annual annuity payment, there are ways in which an installment sale differs from an annuity arrangement. There are good arguments to make in favor of treating the annuity transaction like an installment sale and withholding the 3.33% as each annuity payment is made, but at this point it is prudent to withhold the entire 3.33% at the time of the transfer of land in exchange for a CGA.

A logical solution for this withholding requirement is to set up a 5% sale and 95% gift. The 3.33% of the annuity contract value could be withheld from the sale portion. Because the donor will be able to reduce California withholding for other income, there will be minimal impact on the donor. When the seller/donor files a personal income tax return in the year following the CGA transaction, he or she will then receive a refund of any amount withheld that is not offset by taxable income.

Example 4.7.6B Gift Annuity for Land


Donor has development land valued at $520,000 with basis of $52,000 and transfers the land for a payment of $20,000 and a $500,000 charitable gift annuity. The charitable deduction is $200,000 and the annuity contract value is $300,000. Donor has a gain of $18,000 on the sale and $270,000 gain ($300,000 FMV - $30,000 basis) on the gift annuity. Total gain is $288,000 and the 3.33% withholding amount is $9,600. The net payment to the donor is $20,000 - $9,600 or $10,400. The donor may then either reduce other withholding or receive a refund on the $9,600 after filing the California tax return.

Example 4.7.6C Gift Annuity for Home


Donor has a principal residence valued at $800,000 with basis of $100,000 and transfers the home for a charitable gift annuity. The charitable deduction is $300,000 and the annuity contract value is $500,000. Donor has gain of over $100,000 on the annuity contract value, but there is no California withholding for the sale of a principal residence.

Example 4.7.6D Gift Annuity for Remainder in Home


Donor owns a home valued at $1,000,000 with basis of $100,000 and transfers the remainder interest in the home for a charitable gift annuity. The remainder value is $600,000 and is exchanged for a gift annuity. The CGA deduction is $350,000 and the annuity contract value is $250,000. Donor has gain of over $100,000 on the annuity contract value, but there is no California withholding for the sale of this remainder in a principal residence.

For your general information, additional materials about the 3.33% withholding requirement are available at http://www.ftb.ca.gov/individuals/wsc/California_Real_Estate.shtml.

Charitable Lead Trust
Real estate can work very well with a charitable lead trust (CLT). The best real estate scenarios for CLTs include the following characteristics:

1) income-producing real estate,
2) passive income such as rental or lease income (no unrelated business income),
3) no debt, and
4) desire to hold the real estate long term (no sale inside the CLT).

If the above conditions are met, then real estate and CLTs can produce wonderful results. For a full discussion of the benefits and limitations of CLTs, see GiftLaw Pro 3.5 and 3.6.

Pooled Income Fund
Real estate is not generally recommended for a PIF, because of the illiquid nature of real estate. In addition, many PIFs may not accept real estate. With gifts of real estate, it may take months or even years for a PIF to dispose of the property. In addition, if the real estate does not produce any income, the overall return of the PIF will likely diminish since this PIF investment asset is unproductive. This can cause unhappiness and unrest among other PIF beneficiaries.

In the event the real estate is income producing and the PIF is willing to accept real estate, then it may be a worthwhile planned giving option. At this point, a donor would usually review the benefits and drawbacks of a PIF in comparison to a CRT and CGA, e.g., setup costs, payout options and tax deductions. Afterwards, a donor should select the gift plan that best accomplishes his or her goals.

Case Studies on Gift Annuity, Lead Trust and PIF

Double Discounting Through a Lead Trust and LLC:   Barry and Tracy Fletcher, both age 55, own farmland inherited from Tracy's grandfather five years ago. At that time, the farmland was valued at $1.5 million and, therefore, this is their cost basis in the property. The current fair market value of the land is $2.5 million.

A Restful Retirement Retreat:   Several years ago Mother and Father built a unique home on 45 acres of beautiful rolling hills and woods. Father passed away three years ago and Mother now solely owns the 45-acre parcel and home.

Funding a Chair with Depreciated Property:   Jonathan and Brenda Williamson have owned a warehouse that they have leased to their family corporation over the last 25 years. The warehouse is currently valued at $1,000,000, is free and clear of debt and is now fully depreciated. Their cost basis is $50,000, which in essence represents the value of the land.

Related Topics on Gift Annuity, Lead Trust and PIF

3.4.5  Gift Annuity for Home:    The gift annuity for home is a combination of two qualified charitable agreements. The donor may desire to live in his or her home for life and to receive annuity payouts. If the donor were to create a life estate, the remainder could be transferred to charity and the donor would receive a charitable deduction.

3.5.5  Lead Unitrust:    A charitable lead unitrust must make a payment equal to a fixed percentage of the net fair market value of the trust property, determined annually. Normally, the lead trust is valued on January 1 of each year and, to simplify administration, the trust will make an annual payment at the end of the calendar year. However, it is permissible to value the trust at any date or even to use a combination of dates. Reg. 20.2055-2(e)(2). Reg. 25.2522(c)-3(c)(2).

3.6.1  Double Discount Lead Trust:    Lead trusts provide wonderful leveraged gifts. The gift and estate tax deduction, of course, is equal to the present value of the income to charity. When the Applicable Federal Rate approaches 6% or lower, a lead trust paying 8% will provide a significant gift or estate tax deduction. Depending on the trust term, the deduction can range from 60% to 100% of the lead annuity trust value.

      Quiz-Basic



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