Given the current real estate market, some owners are feeling more charitably inclined than they used to be. The thought crossing their minds is something along the lines of, “Well, if I can't sell it, maybe I can donate it and get some benefit through a tax deduction.” Some donations then proceed relatively smoothly — like the donation of an apartment building conveniently located near a university to use as a dorm or a lot adjacent to a school to expand its playground. The donations that go smoothly share a number of commonalities: a willing donor, an interested donee, no mortgage, no environmental issues and realistic expectations of value for the tax deduction. If any of these factors are lacking, either the donation process will be difficult, or it may not be completed at all.
If the property is subject to a mortgage, the mortgage holder may not allow the donation. Even if the mortgage holder does allow it, the “bargain sale” tax rules may reduce the net value of the donation to the point that the donor will reap no tax benefit (or even incur a tax bill). These rules treat the amount of the mortgage as if it were cash proceeds and, therefore, trigger some or all of any gain upon donation. This is true even if the mortgaged real estate is inside a partnership or limited liability company.1 If the mortgage is relatively low compared with the net value of the property, it may still make sense to proceed with the donation, since the charitable deduction may more than offset the recognized gain. If the property subject to the mortgage would be sold at a loss, rather than a gain, the loss can't be recognized.2
Speaking of losses, one question that's often asked these days is, “What happens if I donate real estate in which my cost basis is greater than the appraised value?” Unfortunately, that loss is lost: a donation isn't a “sale or exchange” that would allow the loss to be recognized. The typical advice would be to sell the real estate, take the loss and donate the cash, but the problem today is that the first step simply isn't feasible.
For real estate donations, valuation is always an issue. The donor must obtain a qualified appraisal,3 and the donee will typically either review that appraisal or obtain its own. The donee doesn't have to agree with the donor's valuation, but most donees don't want to become involved in a dispute between a donor and the Internal Revenue Service by being associated with a donation that's significantly overvalued on a tax return. Donees will need a valuation for their internal records, so if they don't use the donor's appraisal for that purpose, they will want their own. And speaking of the IRS, looking at the court cases decided this year,4 valuation of donated real estate appears to be a hot topic. Note that if the donee sells the real estate within three years of the donation, the donee must report the sale amount to the IRS on Form 8282, so any significant discrepancies between the proceeds and the deduction will be obvious.
Real estate developers or professionals who contemplate disposing of excess real estate by donation face additional hurdles. Especially when the donee is a governmental entity, the IRS may assert that the donation is really part of an arrangement to receive zoning variances or other benefits.5 If the IRS is successful with this assertion, no charitable deduction is allowed: Instead, the basis of the transferred real estate is capitalized into the developer's remaining land. If the real estate donated is inventory, the donation deduction is limited to the lesser of value or basis,6 which may not be the result the donor was expecting.
Real estate isn't the typical asset for a rushed year-end donation. Donations of stock can be completed in one day; real estate donations typically take much longer. My experience is that a condominium donation could be done in less than a month, but commercial real estate will take six months to a year given the need for due diligence by all the parties. But even with the challenges and the current market environment, a well-planned donation of real estate can be a success for the donor and the donee, with the added benefit of a tax deduction.
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- See Revenue Ruling 75-194, 1975-1 C.B. 80; Maxine Goodman, 2000-1 U.S.T.C. par. 50,162; and Private Letter Ruling 9533014 (May 15, 1995), for details of the gain calculation.
- Treasury Regulations Section 1.1001-1(e).
- Treas. Regs. Section 1.170A-13(c)(3).
- Boltar, L.L.C v. Commissioner, U.S. Tax Court, 136 T.C. No. 14 (April 5, 2011); Comm'r v. Simmons, D.C. Circuit Court of Appeals, 2011-2 U.S.T.C. par. 50,469 (June 21, 2011); and Friedberg v. Comm'r, T.C. Memo. 2011-238 (Oct. 3, 2011).
- Stubbs v. U.S., 70-2 U.S.T.C. par. 9468 (June 16, 1970); Sutton v Comm'r, 57 T.C. 239 (Nov. 17, 1971); Grinslade v Comm'r, 59 T.C. 566 (Jan. 29, 1973); and Ottawa Silica Co. v. U.S., 83-1 U.S.T.C. par. 9169 (Jan. 26, 1983).
- Internal Revenue Code Section 170(e)(1)(A).