In 2014, the widow of the movie director, John Hughes, donated the family’s Illinois mansion to Northwestern Lake Forest Hospital. After allowing another charity to use the home for a fundraising event, the hospital sold the home and used the proceeds to expand its campus.
Although many of us are familiar with the donation of appreciated securities, such as stocks, bonds, and mutual funds, it is less frequent that we think about the donation of real estate to charity.
Two basic factors might be considered in contemplating whether to make a gift of real estate to a charity or donor advised fund. One factor to consider is whether the property has a significant built-in long-term capital gain on which the owner would incur a significant capital gains tax upon sale. A second factor to consider is whether the property is relatively easy for the intended charity to liquidate with minimal chance of incurring any liability.
However, when contemplating the gift to charity, beware of these four potential tax traps:
1. When you donate real estate to a public charity, you generally can deduct the property’s fair market value. But when you donate it to a private foundation, your deduction is limited to the lower of fair market value or your cost basis in the property.
2. If the property is subject to a mortgage, you may recognize taxable income for all or a portion of the loan’s value. And charities might not accept mortgaged property because it may trigger unrelated business income tax. For these reasons, it’s a good idea to pay off the mortgage before you donate the property or ask the lender to accept another property as collateral for the loan.
3. Failure to properly substantiate your donation can result in loss of the deduction and overvaluation penalties. Generally, real estate donations require a qualified appraisal. You’ll also need to complete Form 8283, Noncash Charitable Contributions, have your appraiser sign it and file it with your federal tax return. If the property is valued at more than $500,000, you’ll generally need to include the appraisal report as well.
4. If the charity sells the property within three years, it must report the sale to the IRS. If the price is substantially less than the amount you claimed, the IRS may challenge your deduction. To avoid this result, be sure your initial appraisal is accurate and well documented.
We would be delighted to consult with you if you should ever contemplate the donation of real estate to charity.