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Thursday October 17, 2019

Article of the Month

Part II - Investor or Dealer? Gifts of Real Estate and Donor Classification


Philanthropically motivated individuals increasingly understand the value of gifting appreciated real estate to charity. Donors are often able to claim a deduction for the property's fair market value while also bypassing capital gains tax that would otherwise be due if the donor sold the property. This is a win-win solution for the donor from a charitable and financial standpoint.

What is the result, however, when a donor is classified as a "dealer" of real estate and decides to make a gift of real property to charity? In that case, the property is considered an ordinary income asset and, as such, the donor's deduction will be limited to cost basis. On the other hand, if the donor is considered an investor, he or she will be able to claim a fair market value deduction for the gift.

The distinction between dealer and investor is an important factor that advisors must take into consideration when guiding clients through the charitable giving process. While some cases may be clear-cut, in other times the line may be blurry.

Part I of this article shed light on the important distinction between real estate investors and dealers, provided factors that advisors should take into consideration when making this determination and offered case examples to illustrate each factor. This article will use the factors presented in Part I to examine two hypothetical case studies where a client makes a gift of real estate to charity. As such, it is important to read Part I prior to reading this article in order to better understand these case studies. This article will also explain how a charitable remainder unitrust is a potential solution for a donor who wishes to make a gift of dealer-classified property. By examining case examples and understanding the factors used to determine whether a property owner is a dealer or investor, advisors can guide their clients toward a strategy that will maximize their tax benefits while simultaneously fulfilling their clients' philanthropic goals.


The following two case studies will apply the five factors discussed in Part I of this article series to determine whether the property owner is a dealer or an investor with respect to the property in question. The five factors include:
  1. Frequency, Number and Continuity of Sales
  2. Nature and Purpose of Holding or Purchasing the Property
  3. Nature and Extent of the Taxpayer's Business
  4. Advertising, Solicitation and Sales Activities
  5. Extent and Substantiality of Transactions

1. Case Study I


Kevin is a man of many talents. He has derived most of his fortune from his restaurant business. Thirty years ago, Kevin opened his first restaurant and found great success. Today, he owns and manages dozens of restaurants across the country. While his primary focus is his restaurant business, Kevin has also dabbled in other business ventures, such as investing in a tech start-up company and selling culinary tools online. Just five years ago, Kevin partnered with a successful real estate developer to buy and develop a parcel of land for residential purposes. Kevin and the developer successfully zoned the property, installed roads and utilities, divided the land into eight lots and later sold the lots for a substantial profit.

Kevin has always had a heart for charity. Each year, his restaurants provide holiday meals to organizations that feed the homeless. This year, he wants to make an additional gift to his favorite local charity. Approximately 15 years ago, Kevin purchased a rental property ("Property A") and has rented it out to various tenants throughout the years. The fair market value of Property A has increased significantly, and Kevin thinks this would be a great asset to gift to his favorite charity.

Kevin visits with his advisor, Sophie, about his plan. Kevin hopes that by making a gift of Property A, he will be able to further the mission of his favorite charity while also maximizing his tax benefits. Kevin asks Sophie if this gift would provide him with a large charitable income tax deduction for the fair market value of the property and allow him to bypass the capital gains tax that would be due if he sold Property A himself.


Based on the facts provided, Sophie explains that Kevin will likely be considered an investor with respect to Property A and, as such, will receive a fair market value deduction for his charitable gift.

The first factor that Sophie analyzed was the frequency, number and continuity of Kevin's past property sales. While Kevin has sold real estate in the past, it is questionable whether his one-time development project and sale of eight lots would be considered "substantial" for the purposes of analyzing the first factor. Even if a court were to determine that Kevin's past real estate sales were substantial in number, it is unlikely that it would find his sales activities were frequent and continuous. Rather, the facts indicate that Kevin's past development project was the only time he developed and sold real estate. In addition, Property A is completely separate and unrelated to the eight lots that Kevin developed and sold in the past. Thus, it would appear that the first factor weighs in favor of investor, rather than dealer, status.

The second factor, the nature and purpose of holding the property, focuses on the property owner's intent. Here, Kevin purchased Property A with the intent to hold it as an investment and rent it out to tenants. This intent is further evidenced by the number of years that he has held Property A and the fact that he did indeed rent it to tenants during those 15 years. He did not intend to develop and sell the property. Therefore, this factor favors an investor classification.

The third and fourth factors also favor classifying Kevin as an investor. The facts do not indicate that Kevin was actively involved in improving or developing Property A. In addition, Kevin was not attempting to sell Property A or attract buyers prior to the transfer to charity. As such, the third and fourth factors do not support a dealer-type classification.

The last factor looks at the overall level of the property owner's real estate activities. Here, Kevin has profited from prior real estate sales. However, his full-time occupation and primary income-producing activity does not appear to be developing and selling real estate. The facts suggest that Kevin's restaurant business is his primary income-producing activity, thus, this factor weighs in favor of investor status.

Taking all five factors into consideration, Sophie determines that the facts support classifying Kevin as an investor with respect to Property A. As such, by making an outright gift of Property A to his favorite charity, Kevin will be able to claim a deduction for the property's fair market value and bypass capital gains tax.

2. Case Study II


Randall has always had a knack for finding real estate with potential. Buying, selling and developing real property is his true passion. Over the course of 15 years, he has sold 29 parcels of land and recently started to develop residential neighborhoods. Three years ago, Randall acquired a large parcel of land located close to an up-and-coming area of town. Randall's intent when he purchased the land was to develop and subdivide it into 10 separate lots and then sell the lots for a profit.

Randall moved forward with his plan and, after subdividing, grading and zoning the property, he began posting "for sale" signs and marketing all 10 lots. To date, Randall has sold nine of the 10 lots.

Each year, Randall makes a large gift to his favorite charity. He likes that he is able to make an impact on his local community while, at the same time, reducing his tax bill with a charitable income tax deduction. Randall meets with his advisor, Kate, to discuss his charitable giving plans this year. Specifically, Randall wants to know if he can make a gift of the last remaining unsold lot ("Lot 10") to his favorite charity. Randall hopes that doing so will help offset the income he has received from the sale of the nine other lots. Randall asks Kate if this type of gift is possible and, if so, what type of deduction he will receive.


In this instance, Kate determines that the facts support a finding that Randall is a dealer with respect to Lot 10. The first factor, which looks at the frequency, number and continuity of sales, supports a dealer-status finding. The sale of 29 parcels of land over the course of 15 years could be considered evidence of frequent and substantial sale activity. The facts also indicate that, during the last three years, Randall sold nine lots as part of his most recent development project. Randall's sales appear to be frequent, continuous and substantial. As such, the first factor weighs heavily on the dealer side of the scale.

The second factor focuses on the intent of the property owner. Here, the facts indicate that Randall's original intent when he purchased the property was to develop and sell the property, not to hold onto it for investment. The third factor, which focuses on the property owner's undertakings, also supports a dealer finding. Randall actively managed, developed and improved Lot 10 so that it could be sold for a profit.

The last two factors also weigh in favor of classifying Randall as a dealer. By placing a "for sale" sign on Lot 10 and actively marketing the property, Randall's actions support a dealer finding with regard to the fourth factor. Lastly, the fifth factor, which looks at the overall level of the property owner's real estate activities, supports a dealer classification. The facts do not indicate that Randall was involved in other income-producing ventures. On the contrary, buying, selling and developing real estate appears to be Randall's passion and primary income-earning activity.

Ultimately, Kate determines that the facts support classifying Randall as a dealer with respect to Lot 10. As such, a charitable gift of this property will be limited to Randall's cost basis in the property.


For clients who would like to give dealer-classified real estate to charity, one option to consider is a charitable remainder unitrust. A charitable remainder unitrust is a tax-exempt irrevocable trust that is funded by a donor and makes income payments to the donor or other beneficiaries for life, lives or a term of years. The donor also receives a charitable income tax deduction in the year the trust is funded. After all payments have been made, the remaining trust assets are transferred to one or more designated charities.

When funding a unitrust with property owned by a real estate dealer, the deduction will be based on the donor's cost basis. However, the trust payouts will be based on the fair market value or sales proceeds of the real estate. In addition, the donor will be able to bypass tax on the ordinary income in the year of the gift.

When funding a unitrust with real estate, the donor's attorney will typically draft the trust as a FLIP unitrust. When real property is transferred to a FLIP unitrust, the trust will only pay the net income generated by the property until it is sold. On January 1, after the sale date, the trust subsequently flips to a standard unitrust and will begin making standard payments.

If a donor is considering a charitable gift of both investor and dealer-type property, he or she should not put both properties into the same unitrust. Under the four-tier accounting rules of Sec. 664, payouts from a unitrust may be taxed as ordinary income, capital gain, tax-free income or return of principal. The basic rule is that all ordinary income in tier one must be distributed before any capital gain in tier two may be distributed. As such, a donor would not want to put investment property (subject to preferential capital gains rates) into a unitrust with dealer property (an ordinary income asset, which will be subject to tax at the donor's top bracket). Rather, a separate unitrust should be established for the investment property so that the donor's payments from the capital asset unitrust may receive tier two tax treatment.

Rebecca is a successful entrepreneur. Among her many business endeavors, she often acquires large parcels of property and develops them into commercial buildings or residential structures.

Rebecca has two properties that she is considering selling this year. The first property is a large parcel that she developed and subdivided into 100 separate lots. She very quickly turned around and personally sold 80 of the lots for a substantial profit. The 20 lots that remain have a fair market value of $600,000 ($30,000 per lot).

Rebecca also has an 80-acre parcel that she has owned for 10 years as a passive investment. This parcel could potentially be sold for approximately $2 million.

After hearing about the benefits of a charitable remainder unitrust, Rebecca wonders if she can transfer her 20 lots and 80-acre parcel to fund a unitrust. She likes the idea of using her property to support her favorite charitable organizations while, at the same time, receiving tax savings. In addition, Rebecca has not entered into any binding sales agreements with prospective buyers and, as such, it is still possible to set up a unitrust and avoid prearranged sale problems. Rebecca meets with her advisor, Jack, to discuss how to structure her charitable gift.

Jack explains that the best strategy, in this instance, is to isolate the ordinary income property (the 20 lots) and investment property (the 80-acre parcel) into two separate FLIP unitrusts. Unitrust A will be funded with Rebecca's 20 lots. The total cost basis of the lots is $100,000 and the fair market value is $600,000, resulting in a $500,000 gain. Since these lots are classified as dealer-type property, Rebecca would recognize $500,000 of ordinary income if the lots were sold outside the trust. By selling the lots inside the unitrust, Rebecca will save the ordinary income tax that would otherwise be payable on the $500,000 gain. She will also receive a charitable income tax deduction (equal to the $100,000 cost basis multiplied by the charitable remainder trust factor) and trust income for her lifetime. Note that, because this is dealer-type property, the deduction calculation will be based upon her cost basis, rather than the property's fair market value. The trust payouts, however, will be based on the total value of the trust corpus.

Because Unitrust A will be funded with ordinary income property, Jack explains that when the unitrust sells the lots, the proceeds from the sale will be allocated to tier one for trust accounting purposes. As such, Unitrust A will pay out ordinary income, which will be taxable at Rebecca's income tax bracket of 35%. Therefore, Jack explained that Rebecca's investment property—the 80-acre parcel—should be isolated in a separate unitrust so that it can pay out partly capital gain income, which will be subject to preferential capital gains rates.

Accordingly, Rebecca plans to fund a second unitrust, Unitrust B, with her 80-acre investment property. The charitable deduction will be calculated based on the full fair market value of $2 million, and Rebecca will be able to avoid the capital gains that she would otherwise have to pay if she sold the real estate. In addition, once the real estate is sold, the capital gain will be allocated to tier two for accounting purposes and the trust can be invested primarily in stocks. Thus, the majority of the trust's payouts will be dividends or long-term capital gain taxable at Rebecca's capital gains rate of 18.8%.

Rebecca appreciates Jack's keen insight in suggesting two separate unitrusts and decides to move forward with this plan. Not only is she able to maximize her tax benefits, she will receive an income stream for life and leave a charitable legacy with her favorite organizations after all payments have been made.


The classification of a donor as a dealer or an investor is an important, yet difficult, distinction that must be made in order to accurately report a charitable deduction where the property is gifted to charity. The process of making this determination, however, is not black and white. In Byram v. United States, 705 F.2d 1418, 1419 (5th Cir. 1983), the Fifth Circuit noted the difficulty and uncertainty that exists when it comes to this classification process, stating "[I]n that field of the law—real property tenure—where the stability of rule and precedent has been exalted above all others, it seems ironic that one of its attributes, the tax incident upon disposition of such property, should be one of the most uncertain in the entire field of litigation. But so it is..."

And so it is that advisors are faced with the task of guiding their clients through the somewhat murky waters that exist in the dealer-investor determination process. While there is no bright line, advisors can turn to the factors the courts have presented and the cases in which they are discussed. By understanding these factors and considering how courts have ruled in past cases, advisors can help guide their clients and determine the best charitable giving strategy, given the client's likely status as a dealer or investor.

Published March 1, 2019
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Previous Articles

Investor or Dealer? - Gifts of Real Estate and Donor Classification

How to Collect Charitable IRA Beneficiary Designations

IRA Charitable Solutions — Part II

IRA Charitable Solutions – Part I

Recent Developments with Donor Advised Funds


Shelby Harder, 2018
Dr. Irving Auld and Dorothy
Roher Auld Scholarship

"Many students take for granted what a university has to offer. However, I am thankful every single day for the opportunity to attend this prestigious school. At Lawrence, you have the ability to engage in Socratic debates about the world we live in at dinner, play recreational or NCAA sports, and talk one on one with brilliant professors. At Lawrence, you don't just 'learn' a subject, you are immersed in it. You dive into the liberal arts and these professors show you the beauty in it all, and how everything is tied together. I am a Biochemistry major with a soft spot for rocket science, philosophy, and evolution. Lawrence is my dream school, and it would have never been possible without the Dr. Irving Auld and Dorothy Roher Auld Scholarship. I am forever grateful for their generosity."

Juliana E. Olsen-Valdez, 2018
Carroll Family Scholarship

"Lawrence University is a great place for students looking to embrace their multi-interested approach to learning. As a Geology major, I have spent many long hours in laboratories. But, I have also had the opportunity to organize and lead students on outdoor backpacking trips, help build a stronger community for International students, participate in dialogues on campus initiatives, attend dozens of musical events, and study abroad in a field-based geology program, all while taking classes in a variety of academic spheres on campus. Lawrence, as an institution and student body, creates a collective of learners, listeners, and leaders who are continuously evolving their understanding of the world around them. I am fortunate to have the support of the Carroll Family Scholarship, so that I can say I am a part of this exceptional community too!"

Weiqi "Vicky" Liang, 2019
Marian H. Cuff Endowed Scholarship

"Lawrence is a special institution with nice people around the campus. I better myself by trying out different things and using new ways to think critically. Even though I am a Philosophy major, I have successfully taken classes in Anthropology, Biology, Economics, and Government. In addition, I still find many great extracurricular opportunities to explore, such as singing with Viking Chorale, even though I am not a music major. While having the great experience of volunteering at the elderly center last year, I became an elder advocacy coordinator at the Volunteer Community Service Center. At Lawrence, I've learned to handle difficult academic problems while looking forward to exploring possible opportunities. I am very grateful to be awarded the Marian H. Cuff Endowed Scholarship for every year I have been here, and appreciate that the scholarship has provided this wonderful Lawrence experience to me."

Anthony Cardella, 2018
Ansorge Family Scholarship

"I am so excited that I am able to attend Lawrence University. I know that I will make great progress studying piano with Dr. Michael Mizrahi. Since being at Lawrence I've already made a lot of progress and I really love it here. I am so grateful for the Ansorge Family Scholarship that made it possible for me to come to Lawrence because without it, I might not have been able to afford the cost of attending a school that is a great fit for me and a place where I will learn so much and go so far."

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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