Real estate gifts represent a relatively small percentage of overall giving. Charities that do accept gifts of real property tend to realize larger gift amounts from them. Real estate giving broadens the spectrum of charitable contribution options to a charity’s cherished donors.
Charitable gift planners recognize that there are risks inherent to the acceptance of gifts of real property. Gifts of real estate require significant time and effort to manage the gift process.
Due diligence must be conducted to evaluate and assess the property. Ordinarily, an appraisal will be done to ascertain the fair market value of the property. Inspections will be conducted to determine the condition and quality of the real estate. This will include an evaluation of any environmental concerns. A review of title will be completed to identify any defects, encumbrances, or liens. The due diligence process will identify any unusual risks that may be associated with the subject real property. At the very least, there will be a marketing and disposition period to sell the asset. A real estate broker will be selected to market the property. There will be carrying costs of the property for taxes, property insurance, utility expenses, and maintenance until the property is sold.
Within the charity considering a gift of real estate, the advancement team will coordinate the evaluation and assessment of the gift with legal counsel and the finance department. This will provide internal checks and balances. However, it is not uncommon for internal constituencies to have divergent perspectives on the costs and benefits of a real estate gift, both generally and as to a specific property.
What potential liabilities will your charity be exposed to after taking title to a gift of real estate? One important way to insulate the charity from the risks of a real estate gift is to establish a SMLLC that will take title to the gift property.
The IRS has issued a bulletin, 2012-52, validating the use of a SMLLC by 501(c)(3) charities. The bulletin states the following: If all other requirements of §170 are met, the Internal Revenue Service will treat a contribution to a disregarded SMLLC that was created or organized in or under the law of the United States, a United States possession, a state, or the District of Columbia, and is wholly owned and controlled by a U.S. charity, as a charitable contribution to a branch or division of the U.S. charity. The U.S. charity is the donee organization for purposes of the substantiation and disclosure required by §170(f) and §6115.
The SMLLC is a separate legal entity that is wholly owned by the charity. As such, the assets and liabilities of the SMLLC are isolated within that legal entity. The contribution of a real estate gift to the SMLLC means that the title to the real estate is in the SMLLC. The nonprofit does not take title to the real estate gift, so its general assets are not exposed to the risks of the real estate gift. Even though title is taken by the SMLLC, the IRS recognizes a completed charitable gift to the charity and it will acknowledge acceptance of the gift to the donor.
The SMLLC is a flexible vehicle that a charity may utilize routinely for all gifts of real property or only in situations with high degrees of risk. Consider a couple of scenarios that would offer special isolation of risks involved in a real estate donation.
- Identified Environmental Concern– An example of this would be a gift of a farm that had been operated for a long period of time with chemicals and/or pesticides prevalent.
- Long Deferral– This relates to a bequest of a property that you expect will be completed following a long interval, with uncertainty over any intervening risks. Perhaps this bequest is from a great donor who is only 60 years old and has an estimated life expectancy of about 30 years.
- Extended Life Estate– Imagine a gift of a residence subject to a retained life estate from a couple who have a joint life expectancy of a couple of decades. The property is currently in very good condition, but you have concerns about what the condition of the property will be when their life estate ends.
These scenarios illustrate gift opportunities that a charity could have discomfort with when taking title directly to that charity.
Who should make the decision to establish a SMLLC for a particular gift of real estate? The governance structure of charities varies from small to large. In smaller charities, the board or finance committee of the board may review and approve such arrangements. At a minimum, establishing a SMLLC should involve both legal and financial input. These may be internal or external resources.
Let’s review the pros and cons of utilizing the SMLLC in the gift process. The greatest benefit of such an arrangement is that whatever risks and liabilities are associated with that real estate asset, they are contained within the SMLLC. Only the value of the assets in the SMLLC are subject to those risks and liabilities. When the real estate asset is sold by the SMLLC, the proceeds are distributed to the charity. For tax purposes, the sale of the property will be treated on the same basis as if it were sold by the charity. If the sale qualifies as a charitable transaction exempt from taxation, the sale will not be taxable to the SMLLC.
Establishing the SMLLC is very simple and economical. A standard legal template is readily available on the internet so you can see what one says. The cost to establish a SMLLC is well under $1,000, and it can be operational in a day or two. The SMLLC can be used for a single real estate gift or for multiple properties.
The detriment to establishing a SMLLC is having an additional legal entity to account for and manage. It will be a separate entity for accounting purposes with its own income and expense statement and balance sheet. It will be a separate legal entity for tax purposes and file a separate annual tax return to the IRS. From an operational standpoint, there likely will be cash infused into the SMLLC that is necessary to cover annual operating costs until the property is sold. The donor may provide this liquidity in the form of one or more additional cash contributions. If not, the charity will need to fund the cash to pay for operating costs.
If you decide that isolating risk of real estate gifts through a SMLLC is appropriate for your charity, the next question is whether you will have it created as a standing legal structure within your charity or if you will create a separate SMLLC for each real estate gift.
A reasonable option would be to have a SMLLC created as a standing vehicle. This will reflect the concurrence of your legal and financial advisors of the SMLLC structure prior to the acceptance of a real estate gift. It will also provide the opportunity to communicate with your prospective donor early in the gift discussions that an SMLLC will be utilized in the donation process.
Creating the SMLLC offers significant advantages to isolate the risk of a real estate gift to the charity. This does not suggest that due diligence need not be conducted on the property. The charity should still adhere to a formal due diligence process to evaluate and assess the real estate. However, the isolation of risks and liabilities within the SMLLC should provide comfort to legal and financial colleagues and a nonprofit’s board of trustees/directors. It will also be an opportunity to attract larger and therefore more impactful charitable gifts.
Allen Thomas J.D., CFRE, CAP®, is president of Thomas Charitable Advisors, LLC, providing real estate expertise to charitable organizations for gift policies and property transactions. He has 39 years of experience in the nonprofit community, previously serving The American College as vice president of advancement and Devereux Advanced Behavioral Health as vice president of planned giving and real estate.
