Table of Contents
Charitable giving is often a regular part of financial and estate planning. Individuals who have integrated philanthropic goals into their overall estate plans have already answered the question Will I give? The key to achieving those goals lies in the answer to the question How will I give? This discussion of “how” turns on what assets a potential donor has to give. In a sense, choosing the appropriate asset to give to charity becomes a fundamental decision.
Depending on the circumstances, certain types of property are more appropriate to give than others. To decide which asset to give to charity, the donor must understand the differences between asset classes and how these differences affect which deduction the donor can claim for a charitable contribution.
The basic criteria for judging whether to give a particular asset would include whether the donor will realize the optimal deduction for that gift. The optimal deduction depends on several factors:
- Whether the donor can deduct the contribution in the year it is made
- Whether the donor can deduct the gift at its fair market value
- Whether there are ancillary costs required to complete the gift (such as the cost to complete an appraisal)
Of course, the charitable deduction may not be the motivating factor for an individual donor, but for almost every taxpayer, the benefit of a tax deduction is a factor in deciding how to give.
Specific Criteria
Following are three criteria for judging the tax effectiveness of a charitable contribution of a particular asset.
AGI Percentage Limits
In the year of the charitable contribution, the donor can take an itemized deduction for income tax purposes.[i] However, this deduction is limited to a percentage of the donor’s adjusted gross income (AGI) for that tax year.[ii] Any excess value of the contribution not deducted can be carried over into subsequent years (up to five)[iii] The percentage limits do not apply to the gift or estate tax charitable deduction. For purposes of this discussion, we will presume the donor gives to a public charity described as a 50-percent charity.[iv]
Reduction Rules
Generally speaking, a donor can take an itemized federal income tax deduction for a charitable contribution of property at its fair market value.[v] However, this deduction must be reduced by the amount that would be considered ordinary income if the donor had instead sold the property.[vi] The reduction rules are for income tax deductions only and do not apply to the gift or estate tax charitable deduction.
Appraisal Requirement
A contribution of property worth more than $5,000 generally requires an appraisal made by an independent and qualified appraiser to establish the value for deduction purposes.[vii] The appraisal requirement applies to charitable deductions made by individuals, corporations and partnerships.[viii]
Cash
Cash is probably the most common asset given as a charitable gift. A substantial gift of cash – one greater than the usual annual contribution – may be advisable when an individual realizes a large amount of cash in a particular year (a donor who receives a performance bonus or sells an interest in a business). At these times, the donor may benefit from an income tax charitable deduction to offset the relatively outsized tax liability.
AGI Percentage Limits
The deduction for a gift of cash made to a public charity cannot exceed 50% of the donor’s adjusted gross income (AGI) in the year the gift is made.[ix]
Reduction Rules and Appraisal Requirement
There is no reduction rule concerning a gift of cash, nor is there a need for an appraisal.
The simplicity of a cash gift is its greatest attribute for donors: open the wallet and hand it over. However, a cash gift does not offer the additional tax advantage of avoiding capital gain as does a charitable gift of appreciated property. Still, cash has its uses in specific giving scenarios.
Gifting Ideas
Charitable Gift Annuity
Although the current low interest rates leave “savers” at a disadvantage, a good option for the philanthropic saver is the charitable gift annuity. The donor will receive annuity payments for life based on the annuitant’s age and help a worthy cause. A charitable gift annuity is not an investment like a certificate of deposit, since the contribution is irrevocable and the payout rates are generally lower than commercial insurer rates because of the charitable gift component. Still, for those who want to make a gift and generate annual payouts based on that gift, the CGA is a possibility.
Cash Contribution to a Flip CRUT
A “flip” charitable remainder unitrust (CRUT) document includes language to permit the trust to change its payout method from a net-income unitrust to a straight, fixed-percentage CRUT upon the occurrence of a triggering event (as specified in the trust instrument).[x] The sale of unmarketable assets would seem to be within the trustee’s control, but it is listed as a permissible triggering event, an intended exception to the general rule.[xi]
The flip option is particularly attractive when the donor wishes to donate to the CRUT illiquid or hard-to-market assets such as real estate or closely held stock. If the assets do not earn any income, the net-income limitation relieves the trust from the obligation of paying the unitrust amount to the income beneficiary via distributions in kind or of partial interest — with no cash to pay the income tax — or via a forced sale of the contributed property. However, the costs of maintaining the trust property must be paid in the interim. Including cash as part of the contribution to the flip CRUT provides a way to pay the expenses of maintaining the trust as well as the property inside the trust. It should be noted that additional contributions can be made to a CRUT so that cash can be added as needed.[xii]
Securities
A gift of securities is the most common type of non-cash gift. Donors typically give publicly traded stocks, but may also give bonds, mutual fund shares and closely held stock, particularly when reallocating assets in a portfolio. Investors often reallocate assets based on market changes or risk tolerance, but, instead of selling the security, it can benefit the donor to give it to charity instead. At other times, a donor may want to harvest a capital gain, and may select a highly appreciated stock as a charitable gift.
Completing a gift of securities is for the most part easy to do, particularly if the stock is listed on one of the major exchanges or actively traded over the counter. Securities such as closely held stock require more attention because of the need to properly value the gift.
The charitable deduction for a gift of securities depends on the length of time the donor owned the securities: short term (one year or less) or long term (more than one year).[xiii]
AGI Percentage Limits
A gift of short-term securities to a public charity cannot exceed 50% of the donor’s AGI in the year the gift is made[xiv]
A gift of long-term securities made to a public charity cannot exceed 30% of the donor’s AGI in the year the gift is made.[xv]
The excess amount of either of the above can be deducted in subsequent years (up to five years) as previously discussed.
Applying Both the 50% and 30% AGI Limitations in the Same Year
What happens during a tax year when a donor makes both a gift of property held long term subject to the 30% of AGI limitation and a gift of cash subject to the 50% of AGI limitation? Which limits apply and how?
Both AGI limitations continue to apply. The overall limit or ceiling remains 50% of AGI – it is not possible to deduct a cash gift up to 50%, then deduct a separate property gift up to 30%
Reduction Rules
A gift of securities held short term made to a public charity must be reduced by the amount of ordinary income that would have been realized if the securities had been sold rather than donated.[xvi]
A gift of securities held long term made to a public charity can be deducted for the full fair market value of the securities on the date the gift is made.[xvii]
Appraisal Requirement
A gift of a security listed on a market exchange (e.g., on the NASDAQ®) requires no qualified appraisal; the value is the mean price on the date of the gift.[xviii]
Also, a gift of a non-publicly traded stock valued at less than $10,000 does not need an appraisal.[xix]
For a gift of closely-held stock, the appraisal must account for certain factors, including:
- The market price of stocks of corporations engaged in the same or similar kind of business.
- The book value of the stock and the financial condition of the business.
- The earnings and dividend-paying capacity of the business.
- Sales of the stock and the size of the block of stock to be valued.
- The economic outlook for the industry and the particular business.[xx]
Gifting Ideas
Charitable Gift Annuity
A gift of appreciated securities held in the long term to fund a charitable gift annuity is a good match because the donor can spread out the capital gain on the annuity portion of the charitable gift annuity over life expectancy.[xxi]
Non-Grantor Charitable Lead Trust
A non-grantor charitable lead annuity trust (CLAT) can be funded with securities expected to increase in value. The applicable federal rate (AFR) determines the value of the charitable gift at the formation of the CLAT. A low AFR means the CLAT income interest to charity is greater and the remainder interest (subject to gift tax) is lower. Thus, the excess appreciation essentially becomes a tax-free transfer to the family members when the trust term ends.[xxii]
A Note on Depreciated Securities
Securities worth less than the cost basis are not good candidates for charitable gifts. The donor must deduct the fair market value (FMV) of the stock—when FMV is less than the donor’s cost basis, that is a distinct disadvantage. A donor who wants to make a gift of depreciated securities probably should sell the stock and give the proceeds to charity. The donor can then deduct both the loss and the cash charitable contribution.
Retirement Accounts
The general term “retirement account” refers to a retirement plan account such as a 401(k) or an individual retirement account (IRA). The rules regarding these tax-deferred retirement accounts can be quite complex in terms of qualifying as a participant, the contribution amounts, the penalties for early distribution, the required minimum distributions, and the after-death distributions or transfers of the accounts.
The tax-deferral aspect of IRAs and qualified retirement plans is a clear benefit for the owner, but also possibly a tax problem when it is time to make distributions. People rely on these accounts to provide income in retirement, and expect to pass on what they don’t use to loved ones. But for many donors, drawing upon these assets for charitable gifts may be a tax-efficient option.
Limitations on Lifetime Charitable Gifts of Retirement Assets
In general, a lifetime charitable gift using retirement assets as a direct donation to the charity is not possible without the owner first taking a taxable distribution from the account. The IRA Charitable Rollover was an exception: a distribution directly from an IRA to a qualified charity not considered income to the donor.[xxiii] Unfortunately, Congress made the provision temporary and it is not currently in effect. However, Congress renewed the IRA Charitable Rollover in 2008 and 2010, and may do so again in 2012.[xxiv]
Gifting Ideas
Beneficiary Designations
Naming the charity as a beneficiary of an IRA or qualified retirement plan account is an attractive way to make a testamentary charitable gift. Using the beneficiary designation option, the owner designates the charity as the beneficiary for the retirement plan or IRA. This designation controls the distribution of the account (instructions left in a will or trust have no effect if the asset is not left to the estate or the trust). The plan or account administrator will have a beneficiary designation form for the owner to complete. Making the charity the beneficiary of the IRA or retirement plan is the straightforward way to donate those assets to charity.
Considering IRD
The advantage of leaving retirement accounts to charity rather than family and/or loved ones is avoiding the problem posed by income in respect of a decedent (IRD). IRD is income earned by a decedent or income to which the decedent had a right prior to death, but which was not properly includible in his or her gross income prior to death.[xxv] IRD is generally includible in the gross income of the recipient and also includible in the estate, resulting in double taxation of the IRD amounts. This issue is lessened because the recipient may deduct as an itemized deduction the federal estate tax paid by the estate that was attributable to the IRD (the deduction is not limited to the 2% floor).[xxvi] This becomes even more complicated with multiple IRD beneficiaries.
Instead, the testator might plan to leave IRD property, such as a retirement account, to charity, and leave other assets to family members.
Funding a Testamentary CRUT with an IRA
One option is to change the beneficiary of the IRA to the trustee of a testamentary CRUT. The CRUT is a tax-exempt entity and will not pay income tax on the distribution from the IRA. The IRA assets can be sold and invested in income-producing assets.
Real Estate
Despite the recent economic downturn that depressed the value of most residential and commercial property, real estate remains an asset most often held long term with great potential for charitable giving. An individual might own residential or commercial real estate, or both. An individual can hold the ownership in any number of vehicles, such as a business entity or trust such as a real estate investment trust (REIT).
AGI Limitations
As previously noted, a contribution of real property held in the long term can be deducted up to 30% of AGI in the year it is contributed. A contribution of property held in the short term can be deducted up to 50%.
Reduction Rules
The donor can deduct a contribution of real estate for the fair market value if held for the long term. Otherwise, a gift will be valued at fair market value minus any amount that would be considered ordinary income to the donor if the property were sold. The recapture of the depreciation deduction previously taken by the owner is considered ordinary income property.[xxvii] Also, if the owner regularly purchases and sells real estate for profit, the properties might be considered inventory, which is considered ordinary income property.[xxviii]
Appraisal Requirement
An appraisal is necessary to place a value on the real estate. The value is based on its “highest and best use,” which may be different than the donor’s purpose or the how the charity would actually use it.[xxix]
In addition to the appraisal to establish the value of the property, the charity itself will likely require documentation before accepting a gift of real estate (e.g., an environmental review, a clear title search). Charities have gift acceptance policies that outline specific conditions for accepting a gift of real estate. Consultation with the development office is necessary to initiate such a gift.
Gifting Ideas
Gift of a Remainder Interest in a Personal Residence or Farm
A charitable gift of a remainder interest in a personal residence or farm is a possibility for a donor interested in making a significant contribution without a change in personal lifestyle.[xxx] Under this arrangement, the donor retains a life estate, with the property irrevocably being transferred to charity upon death.
Personal residence includes the principal residence, a vacation home, or condominium.[xxxi] A farm consists of land used to produce crops, agricultural products or livestock sustenance.[xxxii] It includes barns, farmhouses and improvements.[xxxiii]
The donor receives an income tax charitable deduction for the discounted present value of charity’s future interest.[xxxiv] This remainder value is determined using the value of the land and improvements, but must be reduced by the value of the life use of the property by the donor.[xxxv]
Flip Unitrusts
Flip unitrusts are often used with real estate. The sale of the real estate is the event which “flips” the net-income charitable remainder unitrust into a straight unitrust.[xxxvi] The trustee uses the proceeds of the sale to invest in income-producing investments.
Tangible Personal Property
Tangible personal property (“TPP”) is defined as property that can be physically touched, excluding land and improvements (buildings and permanent structures).[xxxvii] Examples of TPP include:
- Antiques
- Artwork
- Precious gems and metals
- Stamp and coin collections
- Motor vehicles
Charitable gifts of TPP usually come from the collection of a donor—the donor purchased the property to be part of a whole, and the items are expected to increase in value. These TPP collections are managed, and there will be times when a donor wants to make a lifetime gift of an item for any number of reasons.
AGI Limitations
Like other assets, a contribution of TPP held in the long term can be deducted up to 30% of AGI in the year it is contributed. A contribution of TPP held in the short term can be deducted up to 50%.
Reduction Rules
The donor can deduct a contribution of TPP for the fair market value if held for the long term. Otherwise, a TPP gift will be valued at fair market value minus any amount that would be considered ordinary income to the donor if the property were sold.
The related-use rule is another requirement the donor must meet in order to deduct the fair market value of the TPP. This rule states that if the tangible personal property is unrelated to the charity’s exempt purposes, the deduction must be reduced by the amount of gain that would have been considered gain had the property been sold at its fair market value.[xxxviii]
Furthermore, if the charity disposes of the item within three years of its contribution, the donor is subject to an adjustment of the tax benefit according to the following schedule:
- If the charity disposes of the property in the same tax year the gift is made, the donor’s deduction is the basis.
- If the charity disposes of the property in year two or three after the contribution, the donor must include as ordinary income for the taxable year in which the disposition occurs an amount equal to the excess (if any) of the amount of the deduction over the donor’s basis in the property at the time of the contribution.[xxxix]
There is an exception made if the charity certifies in a written statement either that the property had a related use function and was actually used in that capacity before its sale, or that the intended use of the property at the time of contribution became impossible or infeasible to implement after such gift.[xl]
Appraisal Requirement
In addition to the general requirement that all property valued at more than $5,000 have a qualified appraisal, certain types of property require additional or specific documentation. For instance, gifts of artwork require photographs and attachment of the appraisal itself. Further, due to abuse in claiming deductions, gifts of motor vehicles can be limited to the sale price the charity realizes at a subsequent sale.[xli]
Gifting Ideas
Like a gift of appreciated stock or real estate, there are advantages to giving tangible personal property held long term. However, a donor must be careful to observe the related-use rule. Consider the possible problems created by gifts of tangible personal property made as either a charitable remainder trust or a qualified partial interest gift.
Charitable Remainder Trusts
Generally, funding a CRT with a tangible personal property interest is only appropriate when the trustee has the discretion to sell the property and reinvest the proceeds. An inter-vivos CRT funded with tangible personal property runs into federal income tax deduction problems because the gift is technically a future interest gift in the tangible personal property. The donor cannot claim an income tax charitable deduction immediately; the income tax charitable deduction is deferred until the intervening interest of the donor or any family members have expired.[xlii]
Final Thoughts
People interested in making charitable gifts are not only interested in what good the gifts will do for charity but also in the gift’s effectiveness as part of an estate plan. Discussion of the AGI limitation, reduction rules and appraisal costs might seem arcane and problematic to a layperson. An advisor should be able to frame the issue in terms of how to gain a tax advantage by using one asset rather than another as part of overall planning.
Endnotes
[iii]IRC Sec. 170(d)(1); Reg. Secs. 1.170A-8, 1.170A-10.[↵]
[v]Reg. Sec. 1.170A-1(c)(2): “The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.”[↵]
[vi]IRC Sec. 170(e)(1)(A); Reg. Sec. 1.170A-4(a)(1).[↵]
[vii]IRC 170(f)(11)(C); Reg. Sec. 1.170A-13(c).[↵]
[ix]IRC Sec. 170(b)(1)(A); Reg. Sec. 1.170A-8(b).[↵]
[x]Reg. Sec. 1.664-3(a)(1)(i)(c).[↵]
[xi]Reg. Sec. 1.664-3(a)(1)(i)(d); Reg. Sec. 1.664-1(a)(7)(ii).[↵]
[xiv]IRC Sec. 170(b)(1)(A).[↵]
[xv]IRC Sec. 170(b)(1)(C)(i).[↵]
[xvi]IRC. Sec. 170(e)(1)(A).[↵]
[xviii]Reg. Secs. 25.2512(b)(1), 20.2031-2(b)(1).[↵]
[xix]Reg. Sec. 1.170A-13(c)(2)(ii)(B)(1).[↵]
[xx]Reg. Secs. 25.2512-3(a), 20.2031-3.[↵]
[xxi]Reg. Secs. 1.1011-2(a)(4)(ii), 1.1011-2(c), Ex. (8).[↵]
[xxii]IRC Sec. 170(f)(2)(B).[↵]
[xxiv]Recent legislative attempts to renew the IRA Charitable Rollover include the Public Good IRA Rollover Act of 2011 (S. 557, H.R. 2502). The provision is often discussed as part of the “tax extenders package” which also includes the AMT exemption patch and an option for deducting state sales tax instead of state income tax.[↵]
[xxvi]IRC 691(c); Reg. Sec. 1.691(c)-1.[↵]
[xxvii]IRC Sec. 170(e)(1)(A).[↵]
[xxix]McGuire v. Comm’r, 44 TC 801 (1965).[↵]
[xxx]IRC Sec. 170(f)(3)(B)(i).[↵]
[xxxi]Reg. Sec. 1.170A-7(b)(3).[↵]
[xxxii]Reg. Sec. 1.170A-7(b)(4).[↵]
[xxxiv]IRC Sec. 170(f)(4); Reg. Sec. 1.170A-12(b)((2).[↵]
[xxxv]Reg. Sec. 1.170A-7(c).[↵]
[xxxvi]Reg. Secs. 1.664-3(a)(1)(i)(c) – 1.664-3(a)(1)(i)(f).[↵]
[xxxvii]Reg. Sec. 1.48-1(c).[↵]