Real Estate Usage

FLIP CRUTs Gaining Momentum?

avoid-capital-gainsI have only worked on a few FLIP Charitable Remainder Unitrusts (FLIP CRUTs) in my career (at least ones that came to fruition) and all of a sudden in the past few weeks, I am working on one and talking to a former client about another. I don’t think two FLIP CRUT situations makes for a national trend but they both raised really interesting quandaries, stuff to think about in case you ever get to work on one of these.

Just in case you forgot (or never knew), a FLIP CRUT is a charitable remainder unitrust which has two payment periods. The first period is when the trust is funded (most likely with real estate or other not readily marketable assets) before its assets are sold.  During this period, the donor receives the lessor of the trust income or the Unitrust percentage (% times the principal).  The second period starts on the January 1st in the year following the sale of the assets – the income beneficiaries from that point forward are entitled to typical unitrust payments.  There are primarily for real estate or unmarketable assets being put into a CRT.

So why this post?  A few interesting questions came up very quickly in both situations that are important for us to be aware of (and to watch out for!).  #1 – one of the properties has a business interest (happens to be some sort of agriculture) operating on the property where the current owner’s rent is in some way tied to the production on the property.  The donor’s counsel, as well as other counsel, weren’t that concerned but there is a potential problem there.

If the owner of the property looking to put it in the FLIP CRUT has more than a landlord/renter relationship with that farmer, then that farming enterprise income is considered UBI (Unrelated Business Income) to the FLIP CRUT (once it becomes the owner).  And, the IRS’s brilliant rule regarding UBI in a CRT is a 100% tax on any UBI in a CRT.  In other words, the IRS confiscates any UBI you might have in that trust.  Not the end of the world, by the way, but certainly annoying!

Next issue.  One of the potential buyers of one of the properties is also buying a business interest from the same donor (separate and apart from the real estate going to fund the FLIP CRUT).  The buyer of the business interest wants some sort of legal guarantee on his potential purchase of the property intended for the FLIP CRUT.  That is what we call a prearranged sale – a big “no-no” for CRTs.  No contractual agreements can be in place with a potential buyer prior to the donor putting the real estate into the FLIP CRUT.  Otherwise, the donor is not entitled to his avoidance of capital gains and probably other bad stuff.  Not worth testing these waters – don’t engage in any contracts regarding the intended property for a FLIP CRUT prior to the funding of the CRT.

Lastly, one of the situations was in “full-steam ahead” mode because they felt that they had a buyer willing to buy the property next year (not legally bound but enough to give them comfort that the property would be liquidated soon enough).  Well, they realized that this particular buyer might actually have trouble being able to buy the property.  I always warn donors of the possibility for unforeseen events happening, and having a FLIP CRUT own and manage property for more than a year is certainly something that could happen.

Of course, a CRT being stuck with unmarketable property can be a disaster as eventually the property has to be sold and quite possibly at much less than everyone expected.  Never a good thing with donors who may end up blaming the fundraisers who encouraged this gift option.  Always spell out the potential negative consequences of any gift like this in advance, and preferably in writing (in a nice way but one that is clear enough that you can pull it out of the file to defend yourself if need be).

While two CRTs coming across my path isn’t so earth shaking, I suspect that people are finaling gaining more comfort with their investments and starting to look for options to avoid capital gains.

Have an interesting gift planning scenario?  Please share with us and we will repost (facts altered, of course).

New Planned Giving Technique: Gift of Use of Property!

Generally, as mentioned in a previous post, donors of the “use of property” to a charity do NOT receive a charitable deduction (under the partial interest rule), similar to donations of an individual’s time and other services.

What I discovered on behalf of a pro-bono client last week was that there is a simple, legitimate approach that may net some IMPROVED tax benefits to a property owner providing long term space usage to a nonprofit (improved is bold for good reason!).

Here is the “gift plan” we discovered:

Donor/property owner executes a triple-net lease for $1 a year with the charity using the space as the tenant.  A triple-net lease is one which the tenant is required to pay all expenses and even real estate taxes on the property (or prorated portion related to the percentage of use of the property).

Previously, the donor/property owner was paying for the taxes and upkeep out of his own pocket (or out of the pocket of his legal entity that technically owns the property).

Now, the donor/property owner is free to make tax-deductible contributions that can assist the charity in paying those expenses.

Note, the donor/property owner should have been getting some tax benefits previously for paying real estate tax and even upkeep expenses.  Once the triple-net lease is signed, the donor/property owner no longer gets those benefits (interestingly, on the real estate tax, the property owner (or his LLC) now gets hit with income for the charity paying his tax obligation but still gets to offset that income with the standard real estate tax break).

My initial thought was that the donor was just trading in one set of tax benefits (real estate and business expense deductions) for the charitable deduction – and maybe it wasn’t worth the headaches.

But, I discussed this with the donor and he insisted that he preferred this approach since he said that he saw no real benefit from the tax breaks he had been getting for paying the taxes and upkeep on the property in an LLC (I wonder if that is true but he was fully informed and has his own counsel).

Note: some might question this as a “step transaction.”  That is the code word for doing something indirectly that you couldn’t do directly.  I ran this by 3 very good attorneys (in addition to myself).  This gift plan is NOT about getting a charitable deduction for letting a charity use property where you normally can not (that would be a step transaction).    This gift plan is about structuring the use of property by a nonprofit that MAY give the donor some preferable tax benefits.  Donor gets some benefits but loses others.

Anyway, the donor is free to give more or less to the charity.

Not being an accountant, I am not sure of  the real benefits of the tax breaks for paying real estate or upkeep by an LLC (that is probably losing money or breaking even).  Assuming this donor fully understood the tax benefits all around and he preferred the charitable deduction (which was his personally not to his LLC), I have to assume that there is something here.

As always, this is a complex transaction and I caution any fundraiser in particular in even discussing this with donors.  Absolutely required, the donor’s accountant and legal counsel need to review the entire transaction. The fundraiser’s job is to introduce the idea so that the donor’s counsel can flesh it out.

That being said, it is a nice option for a “donation” of the use of property that has not been discussed really anywhere (except for a short PGDC article that was not complete in its analysis). If it helps the donor, let’s hope that the donor will feel good about giving even more!

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!).