Wednesday April 24, 2024
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5.5.2 Real Estate Sales
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Real estate donors are generally quite knowledgeable about real estate valuation and sales. Frequently, they believe their expertise in a particular area is superior to that of the charity. Therefore, a real estate donor may decide to help the charity by arranging for a buyer at an appropriate price.
On the one hand, the real estate donor desires to make the gift and bypass the capital gain. On the other hand, he or she is very likely to believe that his or her involvement in the sale process will lead to the best possible sale price for the charity.
Outright or Unitrust Gifts
With an outright gift to the charity or a gift to a charitable remainder unitrust with the charity serving as trustee, there are several potential strategies. These include a no negotiations strategy, a buyer waiting in the wings, a contingent oral agreement or a contingent escrow agreement.
No Negotiation Strategy
The safest strategy is for the donor to transfer the property to the charity outright or in trust prior to any negotiations with prospective buyers. Under Rev. Rul. 78-197, there clearly is "no binding agreement" and the charity or trustee may then list the property for sale. After a period of negotiation with various buyers, the property may be sold. This arrangement is clearly within the bounds contemplated by Rev. Rul. 78-197, since there is no "binding agreement" as of the date of the gift. This strategy, however, may not always be practical, particularly if the donor has difficulty to sell property, such as real estate or closely held stock.
What if the property has been listed? What if there is an offer on the property? Under the "no binding agreement" test, the listing does not create a binding legal right with respect to a buyer. Although the listing may create a legal obligation to pay a commission to the real estate agent, this is merely a specific cost of the sale and does not cause a ripening of the gain. Therefore, property subject to a listing but not under contract can be transferred into a charitable trust or outright to a charity.
If there has been an offer or multiple offers without acceptance by the seller, once again there is no binding agreement under Rev. Rul. 78-197. Therefore, the mere presence of offers does not preclude transferring the property to a charity or a charitable remainder trust.
Buyer Waiting in the Wings
What if the property has been listed and one or more buyers have made offers near the listing price? Does the ability of the charity to receive the property and quickly sell to an available buyer cause a ripening of the capital gain?
Fortunately, it is permissible to have buyers waiting in the wings. With any luck, there is more than one active potential buyer. Since this is to some extent a matter of practical proof, it is very helpful to show that two or more prospective buyers were waiting in the wings when the property was transferred. If several buyers are vying for the property, there clearly is no binding agreement under Rev. Rul. 78-197.
An excellent strategy to follow with a buyer waiting the wings is to transfer the property to the charity outright or to the trustee on day one. On day two, the charity or trustee lists the property for sale in an appropriate public newspaper or other venue. On day three, there is no activity. On day four or later, the charity or trustee makes contact with the prospective buyer and both parties sign a sale agreement. If the charity or trustee desires additional safety, it merely can extend the period of time before signing the agreement with prospective buyer. The purpose of the four-day process is to establish a clear record that there is no binding agreement under Rev. Rul. 78-197.
Contingent Oral Agreement
A more aggressive donor may permit the charity or trustee to explore the potential sale of the property with purchasers prior to the actual gift. The charity or trustee offers property for sale on a contingent basis and discloses that it does not own the property, but if it acquires the property during the future identified period, it is willing to sell the property.
Through the contingent listing, the charity or trustee may find prospective buyers. In some cases, the charity or trustee may even enter into a contingent sales contract for a specific time limitation and with an identified buyer.
Under the principles of Palmer and Rev. Rul. 78-197, there is no binding agreement between the donor and the buyer. In this case, the donor has not met the buyer and has had no contact. Since the donor has no contact for the buyer, there cannot be a binding agreement between the donor and the prospective purchaser.
It should be noted that this strategy has not been tested in Tax Court. It relies on a fairly reasonable interpretation of Rev. Rul. 78-197.
Contingent Escrow Agreement
The contingent sale to a buyer strategy may be taken one step further. The charity or trustee can also enter into an actual contingent escrow. Both the charity or trustee and the prospective buyer complete the customary escrow processes, as though the charity or trustee actually owns the property. However, all parties are under notice that any actions taken are explicitly contingent upon the charity receiving the property. A few days before the anticipated closing, the donor then gives the property to charity outright or in trust. In two to five days, the property is sold and proceeds are available to the charity or trustee.
Once again, this strategy has not been tested in Tax Court. However, the donor has no contact with the buyer. Therefore, the donor may reasonably maintain that there is "no binding obligation" between the donor and prospective buyer. Because there is no obligation for the donor to make the gift to the charity, this transaction passes the test of Rev. Rul. 78-197.
Gift Annuity for Real Estate
Approximately one-half of assets owned by donors are real estate. For donors over age 75, a transfer of real property for a gift annuity has several benefits. The donor avoids the time and trouble involved with the sale of real property and receives a contractual promise of fixed payments for one or two lives from the charity. The charity receives the real property, sells the real property and contributes the proceeds to its gift annuity reserve fund to provide the payments to the donor.
However, there are risks to the charity with real estate gift annuities. Typically, the donor has appreciated real property and would like to recognize pro rata the capital gain on the annuity contract portion. It should be noted that the donor bypasses or avoids the capital gain on the gift portion. However, for a single person or a married couple, the capital gain may be reported over the life expectancy of the donor or the couple. Reg. 1.1011-2(a)(4).
Because the donor exchanges a deed to the real property for a gift annuity contract with a specific annuity amount, there is some risk to the charity. If the property sells for an amount substantially less than the negotiated value of the gift annuity contract, the ultimate charitable gift to the charity may be greatly reduced. Because the charity and all of its assets stand behind the gift annuity agreement, even if the value received by the charity from sale of the property is ultimately exhausted, the charity will be required to continue payments to the donor out of its endowment assets. Therefore, charities are very interested in "risk reduction" strategies.
Discounted Charitable Gift Annuities
There are two ways to accomplish a discounted gift annuity. Some organizations discount the appraised fair market value by 15% and issue a gift annuity at the normal organizational rate for 85% of the value. Alternatively, some organizations reduce the gift annuity payout rates by 15% and issue the gift annuity on the full appraisal value. The results are ultimately similar. A 10% gift annuity on the $100,000 property discounted to $85,000 produces 10% multiplied by $85,000, or a gift annuity of $8,500 per year.
Alternatively, the 10% gift annuity payout percentage may be reduced 15% from 10% to an 8.5% payout. An 8.5% payout on a $100,000 property produces an annual annuity of $8,500. The choice of which method to use is primarily a marketing decision by the charity.
Deferred Payment Gift Annuities
A second strategy for risk reduction for a real estate charitable gift annuity is a deferred payment gift annuity. By deferring the payout for 18-24 months, the charity has opportunity to sell the property and transfer the proceeds to its gift annuity reserve. The charity then can invest the proceeds and make payments on the deferred gift annuity. While the charity may incur some selling costs and may not be able to deposit the full sale proceeds in the account, there is a period of deferral for the charity to earn income before starting payments on the gift annuity. In addition, deferred payment gift annuities generally produce substantial gifts to charities. The charity may decide that the risk involved is sufficiently modest that it is willing to move forward with the gift plan.
Gift Annuity "Unprearranged" Prearranged Sale
Another risk-reduction strategy for real estate charitable gift annuities is to use an "unprearranged" prearranged sale. The charity accepts real property only if there are buyers waiting in the wings, a contingent purchase agreement or even a contingent escrow. The charity thus will have a fairly clear understanding of the probable sales price, sales costs and net proceeds. Therefore, the charity may have a higher level of confidence that the gift annuity will be written for the correct price.
Once again, under Rev. Rul. 78-197 the donor has entered no binding agreement to sell to the prospective buyer and the prorated gain allocable to the gift will be bypassed. These strategies also permit pro rata recognition of capital gain allocated to the annuity over the lifetime of the donor.
While the chief financial officer of the charity will undoubtedly want to have the greatest certainty and least risk, the charity must disclose potential risks to the donor's professional advisors. The greater the certainty for the charity, the potentially higher risk to the donor that the transaction will conflict with the "no binding agreement" provision of Rev. Rul. 78-197.
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Case Studies on Real Estate Sales
Give Peace a Chance:
Several years ago, Martha and Frank built a very unique home on 45 acres of beautiful rolling hills and woods. Frank passed away three years ago and now Martha solely owns the 45-acre parcel and home.
Sam Storeowner and the Tax-Free Buyout:
Sam Storeowner was having coffee at Small Town Café when his friend Bob Banker walked into the café. Bob motioned Sam to a booth in the back and said that he wanted to talk to Sam. It turns out that Bob and several friends were in the process of obtaining a charter for a new bank. They were contacting a number of business owners in town and offering them the opportunity to invest.
Buyer Discussion Not a Prearranged Sale:
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.
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