Real Estate

A Tale of Two Gifts


Right now, I am grappling with two potential complex gifts – as complex as they get.  One I am encouraging a smooth, careful approach to accepting it while the other I am pushing back against.  The question is why?

The smoothing sailing one is a gift annuity funded with real estate!  If you have ever taken my Planned Giving Boot Camp, you should know that I caution against even letting your donors know it’s an option.

So, what is different in this case?  I had one conversation with the donor and he relayed how he sincerely wanted to help the charity and cared deeply about their work, that he had done something similar already with a related charity, and that he was fine only receiving an annuity based on the net proceeds of the sale of the real estate. Oh, and he had a buyer who has purchased from him already – not bound legally but someone who has a track record with the donor.

In a ten minute phone call, all of the alerts were turned off. Donor isn’t pushing the envelope, is taking responsibility for the sale and its costs, and a clear winner in my eyes worth hundreds of thousands of dollars to my client.

Next is the one I am having trouble with.  This is for a private individual client but it is a charitable vehicle – a Shark-Fin Grantor Lead Trust funded with life insurance and an annuity.  This is as complex as they get and I should be ecstatic to be involved with this one.  Only problem is that I owe my client a duty to advise against doing anything that is likely to cause trouble with the IRS (or has good chance of being a disaster in anycase).

Firstly, what is a Shark-Fin Grantor Lead Trust funded with life insurance?  It is a lead trust (payments to charity, remainder to family) where the payments to charity are reduced during the “term” – usually the life of the donor – and where a balloon payment to charity happens when the term ends (i.e. the passing of the donor) – most of the balloon payment (from the life insurance owned by the trust) actually goes to the family as an estate tax-free gift.  This is in addition to a big upfront income tax deduction the donors take.

When all of the numbers are crunched, this is the most guaranteed “win, win” as you can find from a tax perspective!  Family gets big upfront deduction.  Annual income tax bite (Grantor trusts send all taxes on income in the trust back to the donor!) is lessened because it is based on small commercial annuity  payments to charity.  Family and charity are winners at the end.  No risks from a numbers perspective.  So, why am I being such a pain to the promoters of this plan?

Do a quick google search on Shark-Fin Lead Trusts and you might find several articles from competing attorneys and financial guys arguing whether these things work or not.  The conclusion from most of the articles is that there just isn’t enough guidance from the IRS.  That means proceed with caution.

In other words, the IRS may eventually look at these (it happens sooner or later) and decide that even though each of the steps in the deal are kosher and not nefarious, the program taken as a whole is a big tax avoidance scheme.  It works too well.

Several years ago, the IRS got wind that promoters had this deal where charities would own large insurance policies but would only be receiving around 10% of the death benefit – the other 90% would go to family tax-free!  The problem was that the donor was taking a 100% deduction for premiums paid through the charity but only giving 10% of the death benefit to charity (herein was the problem!).  Still, the promoters claimed there was nothing wrong and that the charities as owners of the policies could change beneficiaries at will.

IRS didn’t buy it and levied draconian penalties on the charities and families involved. Now, it is strictly forbidden for any charity to own life insurance policy that has any non-charitable beneficiaries. (in fact, it’s those same draconian penalties that makes us wonder if the IRS will somehow attack lead trust arrangements that own life insurance going to both family and charity)

So, with a team of high end promoters pressuring me more than I can withstand, I called the top charitable tax expert in the country (as according to me and many others). I assumed that before I even finished my first three to five words, that he would give me is usual stern warning of “stay away from this one Jonathan.” (meaning not only tell my client not to do it but also remove myself from the case altogether).

Strangely, his response was the opposite of what I expected!  He said as far as he could see, it worked.

So, I withdrew my objections and we’ll see.  Client still needs to decide to fork over a lot of $ to get this done as it requires purchasing a fully paid life insurance policy (as well as the annuity to pay the annual charitable amount). Oh, and the client will use a big law firm to draft and implement the trust (that’s our insurance policy if the deal ever goes sour!).

So, you never know – maybe I will be writing about two of the most complex gift scenarios very soon!

Year-End Giving Quandaries

The year is winding down and with two weeks left, if you are a planned giving officer or fundraiser that deals with out of the box gifts, it is time to remind ourselves of some of the interesting challenges we might experience.

Here is a potpourri of new and old ideas/rules to consider:

  1. Mail box rule – interesting rule since it means that the date of gift is the day the donor puts the check in the mailbox, not necessarily the date stamped by the post office on the envelope.  My approach – for checks received in early January that are dated with a December date on the check – I would give the donors the benefit of doubt, regardless of the postmark.  By the second or third week of January, I might not be as easy going.
  2. Credit card gifts – I just heard an attorney mention that technically, a credit card gift is not completed for charitable income tax purposes until the date of the donor’s next statement.  Yikes – that means that year end credit card giving is problematic?  My advice is to ignore you read this paragraph.  We are usually talking about small gifts?  (ok – remember my rule – bigger the gift, bigger the precautions – so think twice on this one for gifts in the thousands and above).
  3. Last second of the year gift annuities – I just heard the smartest, toughest attorney in the Planned Giving world actually say that he could see the last second – “hey stock is on the way for a new CGA just before new year’s eve” (even WITHOUT a written contract yet) – actually work.  His reason – if the donor had done CGAs previously, a donor’s verbal announcement and transfer, coupled with the donor’s knowledge of these gifts, sounded like a “meeting of the minds.”  My advice: I would take whatever steps possible to make the donor happy and give them their 2011 CGA.  If a stock transfer is initiated in 2011, I would probably figure it out to make it a 2011 gift.  We are not talking about serious crimes here.  Just my approach.
  4. Last second CRTs – To me, there is a limit to what can be done quickly and unless the donor’s attorney is making this happen, I would recommend not guaranteeing anything to your donor.
  5. Last second Real Estate gifts – Ok, these are really hard.  What about two weeks notice?  Get the donor’s attorney involved.  I just heard that the IRS is generally fine with Single Member LLCs, charity being the single member, receiving a risky gift and limiting liability (until  you can figure out what to do with it).  LCCs are easy and quick to set up.  I would only recommend this last second approach on a clear good deal, from a clearly good/friendly donor – who has counsel taking care of it.
  6. Last second Lead Trusts – not possible.
  7. Last second direct IRA gifts – this is a tough one.  If the transfer doesn’t happen until early January, your donor might be facing income tax on the gift (with an offsetting charitable deduction as long as you give him a proper gift acknowledgement).  That result isn’t so horrible but your donor better be informed of the possibility.  Try to find out from the IRA custodian how the transfer will appear in the account of the donor.  If it can show up as a 2011 transfer, even if charity gets it in 2012, I wouldn’t be so concerned.

Please comment and ask your end of year questions!

Charitable Deduction for Donating Use of Space? Lead Trust solution?

Yesterday’s question of the day:  donor is letting charity use space rent free.  Can he take a charitable deduction?

Answer: no.  Partial interest rule problems here.  Generally, unless you give an undivided ownership interest in something, you aren’t entitled to a deduction.  Some exceptions to this rule but not here.

Of course, the nonprofit has a reliable source saying it is possible so they put me in touch.

Here is what we discussed.  What if the donor puts the property or a percentage of it (or shares of LLC) into a charitable lead trust (see prior posts on lead trusts or for more info on these).  Let’s say it is a Grantor version, meaning that the property interest reverts back to the donor at the end of the term.  Assume the payout to the nonprofit from the lead trust is the same as the value of the rent the charity isn’t paying.  On paper, lead trust pays the charity the amount they should be paying in rent – sounds like a wash.

What’s wrong with this scenario?  (putting aside the fact that I don’t even know how it is owned or anything about it so the discussion could be a nonstarter anyway)

Well, the donor could take as a charitable deduction the present value of the payment stream to the charity – there is your deduction! Mission accomplished? No.

What I told this reliable source is that this is a Grantor trust.  That means that the Grantor owns it, pays taxes on it (and there is no offsetting of the trust’s income from the lead trust payments to charity because the donor takes credit upfront for those charitable payments).

In more simple terms, what this Grantor trust will do is create is phantom taxable income to the donor for the value of the phantom rent payments from the charity.

So, the trade off would be:  donor gets upfront deduction but has to pay tax in rest of the years of the trust on rental income (that he isn’t seeing).

I don’t think the donor want’s his tax deduction so badly that he’s willing to pay income tax on the “rent” payments that he isn’t receiving from the charity.

We’ll see about this one.  There are about 1 million and 1 reasons why this will never happen but maybe it will lead to a more sane gift proposal like a percentage interest in the property!  That is a deductible gift that will not cause phantom income and in fact, could lower the donor’s annual tax bills by the assignment of a percentage of income to the charity (which by the way he doesn’t actually has send as cash since charity’s payment is the free rent!).