Can you donate real estate to private foundations?
Yes, it is perfectly allowable to donate real estate to private foundations. However, there are potential drawbacks so donations are quite rare. Donors should proceed with caution because the rules for donating real estate to private foundations differs markedly with the rules for donating real estate to public charities.
Limited Tax Deductions
The predominant reason real estate donations to private foundations are rare is because the charitable tax deduction is limited to the lesser of the donor’s cost basis or the fair market value of the property. As such, if the real estate has appreciated or depreciated significantly from cost basis, the donor receives stunted tax deduction. For real estate that has appreciated in value, the tax deduction is limited to the cost basis (i.e., the original purchase price). For real estate that has depreciated in value, the charitable tax deduction falls with fair market value of the property and there is no recognition of capital loss. The better tax strategy for real estate that has depreciated in value is to sell the real estate to realize the capital loss and then donate the cash proceeds to the private foundation.
The rules for real estate donations to private foundations described above compare unfavorably with the rules for real estate donations to public charities. For donations of real estate to public charities, the charitable deduction is generally equal to the fair market value of the property. Consequently, the donor receives a larger tax deduction for donating appreciated real estate to a public charity rather than to a private foundation. Additionally, donations of real estate to public charities are deductible up to 30% of AGI on an individual tax return versus only up to 20% of AGI for real estate donations to private foundations. For both public charities and private foundations, any excess amount that cannot be used in the current year can be deducted for the next five years until the excess amount is used up.
Real Estate Subject to a Mortgage
Donors should avoid donating real estate subject to a mortgage because it will likely be treated as a self-dealing violation for debt relief to the donor. Self-dealing violations can result in significant financial penalties both for the foundation and for the donor. Furthermore, such a transaction may trigger taxable income to the donor for cancellation of debt of the loan amount. Additionally, if a private foundation rents out real estate subject to a mortgage the income in all likelihood will be subject to the unrelated business income tax rules. For these reasons, donors should avoid contributing real estate encumbered by a mortgage to private foundations. If an encumbered property is slated for donation, the mortgage should be paid off prior to the transaction to avoid detrimental tax consequences.
Pre-arranged Sale of Real Estate
A private foundation should not be used as a pawn to carry out real estate transactions with a pre-arranged buyer. The IRS is concerned that a real estate owner could use a private foundation as a kind of middle man in order to sell real estate to a 3rd party and receive a tax deduction instead of a capital gain from a direct sale. If a contract is negotiated with a buyer before the donation of real estate to a private foundation is complete, the IRS may collapse the transaction and treat it as though the real estate was sold directly by the donor to the buyer.
Private Foundations must have complete freedom to determine whether donated real estate should be kept or sold. The real estate donor may refer interested buyers but should be careful not to enter into any legal contract or commitment on behalf of the foundation. In order to avoid potential problems, the private foundation itself should control the negotiation process with potential buyers.
Reasons to Donate Real Estate
In spite of the potential drawbacks outlined above, there still may compelling reasons to donate real estate to a private foundation. It is easy to imagine how real estate ownership might complement a foundation’s charitable activities in a meaningful way. As a general example, a private foundation that owns and occupies its own small office building is in a more secure position than a foundation that rents office space. Additionally, real estate held for charitable purposes can oftentimes qualify for an exemption from real estate taxes imposed at the county and municipal level of government.
Lastly, if the donor’s cost basis in the real estate is similar to the fair market value, then the charitable deduction available for donating to a private foundation is about the same as donating to a public charity. Remember that the charitable tax deduction for donating real estate to private foundations is limited to the lesser of the donor’s cost basis or the fair market value of the property. If these amounts are similar then the predominant drawback to donating real estate to private foundations is mitigated (i.e., the value of the charitable deduction is not reduced all that much by taking the lesser of the donor’s cost basis or the fair market value).
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