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Wednesday December 2, 2020

Article of the Month

Charitable Gifts of Real Estate - Part III

For many donors, the most significant part of their net worth is real estate. Thus, donors regularly make real estate charitable gifts. As a general rule, many charities prefer gifts of cash, stocks and bonds because these types of gifts are easy to transfer, value and liquidate. In contrast, gifts of real estate may bring legal and financial liability that gives rise to numerous issues the charity must navigate.

Real estate is a unique asset and each gift must be properly tailored to the property and the donor's expectations, while protecting the charity from any issues that may arise. Charities and donors must ensure they are informed about the benefits and pitfalls of gifts of real estate.

This series will focus on real estate donations, discussing the definition of real estate, charitable deductions for real estate gifts, charitable gift options and some best practices. This article will explore structuring real estate gifts using retained life estates.

Structuring Real Estate Gifts

Real estate can be an excellent asset to donate to charity. Usually, a donor will receive a larger tax benefit by contributing real estate to charity, rather than donating the cash proceeds from a sale of the real estate. Gains may be bypassed or avoided if the real estate is contributed to a charity prior to a sale. If a donor donates the cash proceeds from a real estate sale, the donor will be taxed on the gain from the sale of the appreciated real property. Part I of this series touched on the prearranged sale rules. If the IRS deems a transaction a prearranged sale, the donor will not bypass the gain.

There are several ways a donor can structure a transfer of real estate to charity, each with differing benefits and risks for the charity and donor. One planned gift vehicle for contributing real estate to charity is discussed in relation to retained life estates below.

Retained Life Estates

A retained life estate is an irrevocable transfer to the charity of the donor's remainder interest in a personal residence, farm or agricultural land, while the donor retains the right to use the property for life, lives or a term of years. The property must be either a personal residence or a farm. A personal residence is defined as "any property used by the taxpayer as his or her personal residence even though it is not used as his or her principal residence." The regulations specifically state that an individual's vacation home may meet the definition of a personal residence.

In general, a retained life estate allows the donor to continue to live in his or her home and donate a large asset upon termination of the life estate interest. Under Sec. 170(f)(3), a gift of a partial interest in property does not qualify for a charitable deduction. However, a contribution of a personal residence or farm as a retained life estate is an exception to the partial interest rules. Because this is a non-cash property gift, a qualified appraisal is required to determine the value of the residence for income tax purposes.

In practice, the duration of the majority of life estates are for the life of the donor or for the life of the donor and his or her spouse. However, there is no limitation on the duration of a retained life estate. The transfer may be for a life, lives or a term of years. Thus, there is no minimum 10% deduction test for this arrangement like there is with charitable remainder trusts and charitable gift annuities.

Example 1
Kyle is an 80-year old donor who has a soft spot for his favorite charity. He would like to make a substantial gift to benefit the charity using his home. He asks his professional advisor if there are any creative solutions that would allow him to benefit his favorite charity and take a large deduction without having to move out of his home. His advisor explains there is a way he can remain in his home and make a remainder gift of his home, all while receiving favorable tax treatment. The advisor recommends a one-life retained life estate which satisfies all three of Kyle's goals. Kyle informs the advisor his home has a fair market value of approximately $750,000. If he proceeds with the gift, Kyle will receive a charitable income tax deduction of $653,994. At his 22% tax bracket, he may save $143,879 in income taxes. The deduction may be taken up to 30% of Kyle's adjusted gross income in the year of the gift, with the ability to carry-forward the deduction up to five additional years. Upon his passing, the charity receives his home and there is a full estate tax deduction for the transfer. Kyle is required to obtain a qualified appraisal to determine the overall value of the property and allocation between the land and building value. He can obtain the qualified appraisal up to 60 days before the donation or up until the due date, including extensions, of his tax return. He was pleased with the potential outcome and moved forward with contacting his favorite charity to start the gift.
The donor of a remainder interest in a home is entitled to take an income tax deduction for the present value of the remainder interest. The deduction is calculated using the Applicable Federal Rate (AFR) under the Sec. 7520 Valuation Tables and the factors from IRS Pub. 1457. The deduction is reduced for depreciation using the straight-line depreciation method.

The donor is also entitled to a gift tax deduction. In many cases, the gift tax deduction is irrelevant because the life estate is for the donor and their spouse. The unlimited marital deduction would apply to most transfers between spouses.

In a retained life estate for two lives, where the donor is the only owner of the property prior to the creation of the life estate, there are two gifts. One gift is to the second life beneficiary and the second gift is to a charity. The current gift to the second non-donor beneficiary will be reported to the IRS. If the second non-donor beneficiary was a child, the child will be the recipient of a gift of a life estate. The gift of a life estate requires the completion of a gift tax return on Form 709 if the value of the gift exceeds the annual exclusion. The annual exclusion for 2020 and 2021 remains at $15,000 per individual.

The requirements of a gift tax return can be precluded if the donor retains a testamentary power of revocation. The testamentary power of revocation should be added to the donor's estate plan. This causes the gift to be incomplete until the donor's passing. Once the first life estate interest terminates, the present value of the gift is included in the donor's estate, but will not have gift or estate tax consequences. With the estate tax lifetime exemption currently at $11.58 million in 2020 and increasing to $11.7 million in 2021, donors may consider this a viable option. There are many considerations that should be discussed with the donor's counsel to ensure the donor understands the ownership implications of a gift to a child or other non-donor beneficiary. The gift and estate tax implications should be discussed with the donor's counsel to ensure that making a gift of a life estate is an appropriate option.

Example 2
If instead of moving forward with a one-life retained life estate, Kyle was curious if he could include his only son Dylan in a two- life retained life estate agreement for the use of the home after he passes away. Dylan is currently 55 years old and has a strong familial bond with his father. Kyle knows how much Dylan appreciates the family home and memories made there. Kyle asks his professional advisor if it is possible for the retained life estate to also include his son. The advisor informs Kyle that his goals will still be met, but there will be an adjustment to some of the tax savings. By adding Dylan in the two- life retained life estate, Kyle's charitable deduction is reduced from $653,994 to $470,686, a reduction of over $180,000. At his 22% tax bracket, his income tax savings are reduced from $143,879 to $103,551, a tax savings reduction of about $40,000. The advisor also states that a testamentary power of revocation should be included in Kyle's deed to eliminate immediate gift tax consequences for Dylan. With the estate tax lifetime exemption at $11.58 million in 2020 and $11.7 million in 2021, Kyle expects to hold a modest estate at his passing. Even if the estate tax lifetime exemption falls from its high values, Kyle's advisor believes the gift of the life estate to Dylan is unlikely to have any estate tax consequences when Kyle passes away. Kyle understands with his two-life structure how beneficial it would be to allow his son to use the home after he passes away. Dylan will not receive a charitable deduction because he is a non-donor beneficiary. In the end, his three goals of remaining in his home, gifting his home and receiving favorable tax treatment are still met. Kyle is pleased with adding his son in the two-life retained life estate agreement and contacts his favorite charity.
The treatment of estate tax depends on whether the life estate reserved is for one or two lives and the second beneficiary's relationship to the donor. In a retained life estate for one life, when that individual passes away, there is a full charitable estate tax deduction. If the second beneficiary is a surviving spouse, the marital deduction can be taken. If the second beneficiary is any other individual, such as a child, nephew, niece or other individual, the value of the interest is taxable in the donor's estate if the testamentary power of revocation was retained.

Upon the expiration of the life estate interest, the charity receives the property in full. The deed for the remainder interest must not be restricted. Any restrictions may disqualify the donor's charitable deduction. A donor may decide to make a gift of a remainder interest encumbered with a mortgage. However, there is very little guidance from the IRS and the donor should only proceed with advice from a tax professional. There are a couple basic tax principles to provide guidance. First, the charitable deduction should be limited only to the equity portion of the residence. The debt portion should not be included in the calculation. Also, arguably each additional mortgage payment reducing the principal by the donor may qualify for a new charitable deduction.

This gift must be documented in a deed transferred to the charity. The donor and charity have flexibility to determine who must pay for the associated costs while the donor lives in the home, such as property taxes, maintenance costs and insurance. These obligations are typically outlined in agreements called maintenance, insurance and taxes ("MIT") agreements. These agreements define the responsibilities of the donor as the life interest holder. Generally, MIT agreements create an expectation that the donor maintains the property in its current condition. The MIT agreement is helpful to ensure the roles and responsibilities are formalized. The donor should have a clear grasp that the charity is not stepping into the role of landlord through this arrangement.

Because the charity possesses the remainder interest, the charity has an interest in the donor leasing the property or making capital improvements. The agreement may contain conditions such as restrictions on who may lease the residence or requiring that the charity shall receive the lease income once the donor passes away. The donor is expected to ensure the residence is properly maintained, but capital improvements fall outside that scope of maintenance. The donor and charity may agree to split the costs of capital improvements with a separate joint ownership agreement. If the donor agrees to pay all costs for the capital improvement, the donor may receive an additional charitable deduction for the improvement value to the remainder interest holder. A few examples of capital improvements are the homeowner adding a bathroom or bedroom, renovating the kitchen or replacing the house's faulty foundation.

Retained life estates are valuable gift models for the donor that wishes to benefit his or her favorite charity using their personal residence. If the donor's circumstances were to change and he or she does not want to live in the home anymore, retained life estates inherently provides the donor with options. These options include the donor and the charity agreeing to a joint sale of the residence, the life estate interest can be accelerated to the charity or the life estate interest can be used to fund a charitable gift annuity or charitable remainder trust.

Example 3
Brandon, age 80, transferred the remainder interest in his $500,000 home to his favorite charity in 2010. Using the AFR at the time, he received a charitable income tax deduction of $397,490. The remaining value of $102,510 represents Brandon's retained life estate interest. Now in 2020, at age 90, he wishes to move into a retirement home and is wondering what will happen to his life estate interest. The house is now worth $550,000. Brandon spoke with his advisor who informs him that even if he moves out of the home, he is able to retain his life estate interest. The life interest would allow Brandon to lease the home to family, friends or a third-party individual, with the charity as a party to the lease. Brandon decided he did not want to become a landlord and wished to explore other options. His advisor explains that the charity and Brandon have a few options. The most compelling options include a joint sale, acceleration of the life estate or converting the life estate to a charitable gift annuity or charitable remainder trust. In 2020, with the house now worth $550,000 and using the current AFR, the value of his life estate interest is $30,541. Brandon discusses his options with the charity.

If Brandon were to accelerate the gift by transferring his life estate interest to the charity, the charity would then own both the remainder and life estate interest. The charity would own the home in full and Brandon would receive a charitable income tax deduction of $30,541. This amount is deductible up to 30% of Brandon's adjusted gross income in the year of the gift. This structure will allow the charity to sell the home tax-free and use the proceeds for its charitable mission.

If Brandon were interested in receiving cash instead of an additional charitable deduction, Brandon and the charity could engage in a joint sale of the property. The proceeds of the sale would be apportioned between the two parties based on their respective ownership interests. The life estate interest is valued at $30,541 and the charities' interest is the remaining $519,459. If the home is then sold for $550,000 to a third-party buyer, Brandon would receive $30,541 of the sale proceeds and the charity would receive $519,459. Brandon would have to recognize capital gain for his portion, but may be able to apply the $250,000 capital gains tax exclusion for the sale of his home to zero out his tax. He would not receive any charitable income tax deduction in this scenario, but receives a lump sum of cash.

If instead of a lump sum Brandon wanted income payouts for his life, he could fund a charitable gift annuity or charitable remainder trust with the $30,541 life estate interest. He would also be entitled to a charitable deduction for this structure. The charitable tax deduction would be a lesser value than the $30,541 because of the returned value of the income payouts for life, but he would bypass capital gain. If the $250,000 home sale exclusion is applicable to offset capital gains tax, Brandon may consider selling the life interest and funding the CGA or CRT with the cash proceeds. Cash gifts are deductible at higher limits than appreciated property gifts. This would allow Brandon to take a higher deduction in the year of the gift and receive substantially higher tax-free income payouts over his lifetime.

Surprised by the flexibility of donating the life estate interest, Brandon takes more time to think about what he would like to do. He understands the flexibility of his interest allows him many options each with differing benefits.
Once the life estate interest expires, the charity will own both the life estate interest and the remainder interest. Thus, the charity owns the property in full under the doctrine of merger. The charity has the option to hold onto the property as an asset or can sell the property. Because the charity is tax exempt under Sec. 501(c)(3), the charity may sell the property without recognizing any capital gain on the sale.


Retained life estates are one of many different gift models that may be created with real estate, with its own unique benefits. The retained life estate works equally well for the donor with many real estate assets or the donor whose only large asset is his or her primary residence. The next article in this series will discuss funding charitable gift annuities with real estate.

Published December 1, 2020
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Previous Articles

Charitable Gifts of Real Estate – Part II

Charitable Gifts of Real Estate – Part I

Charitable Class and Disaster Relief

Charitable Lead Trusts in a Low Interest Rate Environment - Part II

Charitable Lead Trusts in a Low Interest Rate Environment


Maria Poimenidou, 2020
Theodore Diamandopoulos
Memorial Scholarship

"I am currently a senior double majoring in biochemistry and economics and minoring in Innovation & Entrepreneurship. I cannot express enough how much I appreciate the Theodore Diamandopoulos Memorial Scholarship, without it, my Lawrence experience would not be possible. I have enjoyed being a mentor in the CORE freshman mentorship program, playing and working for the Women's Basketball team, competing in Model United Nations, interning as a lab assistant at the MD Anderson Cancer Center in Houston, hosting a pilot STEM program for young unaccompanied refugees in Greece, and volunteering through KidsGive during a field trip to Sierra Leone. Thank you so much for supporting me in doing the things I dream to do."

Jelani Jones, 2021
Marie Dohr Memorial Scholarship

"Being at Lawrence has and continues to be a joy for me. I feel that I have grown so much as a musician, a teacher, and a friend through the awesome community of professors and friends I have met here. I feel that I am blessed to have such an awesome violin professor, and all the faculty members in the education department are so amazing. I have come to see Lawrence and the state of Wisconsin as my home, and I wouldn't change a thing."

Maggie Wright, 2021
Margaret S. and W. Paul Gilbert Memorial Scholarship

The scholarships I receive at Lawrence allow me to experience anything that I want to. I can pursue my love of Biology and Chemistry in classes that are engaging, with professors who care individually about their students. These scholarships also give me the freedom to participate in numerous extracurriculars that Lawrence offers as well, like the Fencing Team and the American Medical Students Association. All of the opportunities Lawrence offers me remind me how grateful I am to have received the Margaret S. and W. Paul Gilbert Memorial Scholarship."

Molly Chadwick Reese, 2020
Anne Prioleau Jones Tuition Scholarship in French

"Attending Lawrence is a privilege few are granted. Every moment spent at Lawrence solidifies a lifelong membership in a special group of peers, known as Lawrentians. The esprit de corps that Lawrence fosters makes the connection between students and mentors new and challenging, with both parties in a constant state of curiosity, respect, and encouragement. My experience as a language learner at Lawrence has not only helped my comprehension of the French language, but has enhanced my ability to communicate and connect with people in ways I never expected before attending Lawrence. As a French major and a student following a pre-medicine track, I have been afforded the privilege of diving into the sumptuous depths of the humanities, while satiating my hunger for scientific knowledge in concert. From this, I am able to fully appreciate the wonders of a liberal arts education. If not for the Anne Prioleau Jones Scholarship in French, I would be unable to join my peers in this quest for knowledge. I am very grateful for the donors' generosity."

Milwaukee-Downer Scholarships and Professorships

Some of the many recipients of Milwaukee-Downer scholarships gather for a photo with Carolyn King Stephens M-D'62 and Marlene Crupi-Widen M-D'55 in January 2014 at the annual scholarship luncheon.

Rosamund Victoria Bille Adler Scholarship
Dr. Charles E. Albright Scholarship
Helen Daniels Bader Scholarship
James G. and Ethel M. Barber Scholarship
Catharine Beecher Endowed Fund for Downer Women
Bessie A. Bell Scholarship
Berk Scholarship
Frederick C. Best Scholarship
Beta Study Club Scholarship
Lynde Bradley Scholarship
Lucia R. Briggs-Alumnae Scholarship
Edith Lange Brooks Scholarship
Anne Barman Caldwell Scholarship
Alice Miller Chester Scholarship
City of Milwaukee Student Funds Scholarship
Milwaukee-Downer Class of 1940 Fund
Milwaukee-Downer Class of 1942 Fund
College Endowment Association Scholarship
Janet Cope Crawford Scholarship
Jessie Mabbott Daniels Scholarship
F. T. Day Scholarship
Rufus Dodge Scholarship
Julia P. Ely and Hannah R. Vedder Memorial Scholarship
General Endowed Scholarship - M-D College
Dr. Alfred W. and Mrs. Ada F. Gray Scholarship
Berenice E. Hess Scholarship Endowment
Lucille Ray Hibbard Scholarship
Belle Austin Jacobs Scholarship
Helen McDermott Jurack and Ronald J. Mason Scholarship
Marjorie S. Logan Scholarship
Nellie Maxwell Scholarship
S. Annabelle & Paul McGuire Scholarship
Memorial Scholarship Fund - Milwaukee-Downer
Milwaukee-Downer Class of 1953 Scholarship
Milwaukee-Downer Class of 1955 Scholarship
Milwaukee-Downer Class of 1956 Scholarship
Milwaukee-Downer Class of 1957 Scholarship
Milwaukee-Downer Class of 1958 and 1959 50th Reunion Scholarship
Milwaukee-Downer Club Scholarship
Milwaukee-Downer/Lawrence College Consolidation 50th Anniversary Scholarship
Francis Evelyn Kelley Morgan Memorial Scholarship
O'Neill-Anderson Family Scholarship Endowment
Elizabeth A. Olson Scholarship
Gilbert Haven Peirce, Sr. and Emma Elizabeth Manor Peirce Milwaukee-Downer Scholarship
Aleida J. Pieters Scholarship
Matilda Siefert Puelicher Scholarship
Elizabeth Ann Richardson Scholarship
William M. Ross Memorial Scholarship
Elizabeth Rossberg Scholarship
Charles Frederic Sammond Scholarship
Mildred L. Schroeder Scholarship
Sivyer Educational Fund for Women
Marion Merrill Smith Scholarship
Dr. Elizabeth A. Steffen Scholarship
W. Mead and Elizabeth McKone Stillman Scholarship
Strzelczyk Family Scholarship
Clare Scherf Sweetman Scholarship
Raymond H. and Jane K. Taylor Scholarship
Jerline E. Walfoort Memorial Scholarship
Barbara E. Wehr Fund
Harmony Weissbach Scholarship
Martha and Frances Wheelock Scholarship
James G. and Ethel M. Barber Professorship of Theatre and Drama
T. A. Chapman Professorship in Music
Alice G. Chapman Professorship in Physics
Alice G. Chapman Librarianship
Milwaukee-Downer College and College Endowment Association Professorship

Angela Small Fry Intia, 2019
Maurine Campbell Scholarship

"Thanks to the Maurine Campbell scholarship, I have been able to attend the amazing school that is Lawrence University. With the help from this scholarship, I have been able to pursue my dream career in chemistry working with the outstanding and extremely helpful faculty here. Even outside of chemistry I take the time for exploration into my interests and want to give back through my work as a resident life advisor, stock room assistant, and student supervisor at Bon Appetit. Everything I have learned here, academically or not has forever molded the person I am today."

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