Case Study: The "Un-Gift"

Case Study: The "Un-Gift"

Case study posted in Outright Gift on 26 April 2005| 4 comments
audience: National Publication | last updated: 18 May 2011
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Abstract

When considering making a charitable gift, most people think in terms of donating of cash, securities, or other property. However, a gift of the "use of" real or tangible property can be just as valuable to the charitable donee.

FACTS:

Dr. Ben Walters has been on the medical staff of the local nonprofit community hospital for over thirty years. During this time he has delivered thousands of babies and has become a beloved and highly respected member of the community.

Twenty years ago Dr. Walters purchased some vacant land adjacent to the hospital campus where he then built a three-story medical office building. In addition to housing his own practice in one of the prime ground-floor suites, the balance of the building is rented to other physicians, a pharmacy, and a medical lab.

Dr. Walters, now age 65, has announced he is hanging up his stethoscope. Ben Walters and wife Betty are appreciative of the hospital and community that provided Ben with the facilities, equipment, and staff to conduct his practice. Dr. and Mrs. Walters have decided they would like to give something back.

The hospital is expanding its "Healthy Beginnings" pre-natal education program and is looking for space for its staff and to conduct classes. Dr. Walters is well aware of the program because he served as its founding medical advisor. With some minor modification, Dr. Walters' office would be perfect for this use.

SOLUTION:

The Walters will execute a one-year lease of his former medical suite to the hospital for the sum of $1 per year. The hospital will be responsible for any tenant improvements and for utilities just as the building's other tenants. At the end of each year, the hospital and the Walters will assess the program and the hospital's needs, at which time they may renew the lease.

INCOME TAX CONSEQUENCES:

Unlike gifts of cash or property, the Internal Revenue Code does not allow a charitable income tax deduction for donations of the rent-free use of property. The reason is that such gifts represent a gift of other than the donor's entire interest in the property.1 Therefore, the Walters will not be able to claim a deduction for the fair market value of the rental income they are donating.

While this fact surprises many donors, the reason is quite logical. To allow a deduction would be to allow a double tax benefit: a charitable deduction and avoidance of recognition of rental income. Put another way, if Dr. Walters were to rent his office to another doctor for its full fair market value and then donate the cash rents he received to the hospital, he would first have to include the rents in his taxable income and then claim an offsetting charitable deduction. The income tax result of simply donating the rent-free use of property to charity is the same, but without having to claim the additional income and a deduction of the income tax return! The result from an income tax planning viewpoint is an "un-gift."

GIFT AND ESTATE TAX CONSEQUENCES:

Unfortunately, as with the income tax charitable deduction, because a gift of the use of property consists of less than the donor's entire interest in the property, the transfer will not qualify for either gift or estate tax charitable deductions. 2 Accordingly, the fair market value of the foregone rental income will be considered a taxable transfer for gift tax and, possibly, estate tax purposes. That's the bad news.

Here's the good news: The gift tax rules permit individuals to transfer $13,000 (indexed for inflation) per year to an unlimited number of "persons" (which include charitable organizations) without having to file a gift tax return or to pay any tax.3 Couples electing gift-splitting can exclude $26,000 per year.4

In this case, the value of Walters' gift falls within the annual exclusion amount. Therefore, no tax will be due.5

CHARITABLE BENEFIT:

From the hospital's standpoint, however, it doesn't consider this donation an "un-gift" at all. For donor recognition purposes, the hospital plans to recognize Dr. and Mrs. Walters for the fair market value of their contribution because, to the hospital, this significant donation is just as valuable as cash!


  1. IRC §170(f)(3)(A). Other examples cited include rent-free use residential real property to charity; a free loan of artwork to a museum; and the rent-free use of automobiles to an educational organization for use in driver education programs. Donors should be aware that if they donate the use of residential rental property (e.g., a week at the donor's rental beach house is donated for a charity auction), the successful bidder's use of the home is considered the homeowner's personal use for purposes of applying section IRC §280A's limitation on deductions related to a dwelling unit used as a residence. See Rev. Rul. 89-51.back

  2. See IRC §§2522(c)(2) and 2055(e)(2). IRC §2503 provides an exception for loans of artwork provided they are made to an organization described in section 501(c)(3) and deductible under section 501(c)(other than a private foundation), and the use of such work is related to the donee's tax-exempt purpose (e.g., a museum).back

  3. IRC §2503back

  4. See Reg. §25.2513-2 regarding the manner and timing of the election.back

  5. The annual gift tax exclusion applies only to lifetime transfers; therefore, donors may wish to include a provision that terminates the arrangement upon the death of either or both donors. Other creative options may be available based on the circumstances and planning goals of the donor(s). Donors contemplating these types of gifts should always consult their professional advisors regarding all tax consequences.back

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Comments

Gift Tax Consequences

Nancy, thanks for asking these important questions. In response, we have expanded the case study to mention gift and estate tax issues.

Un-Gift

Please note, however, that just this kind of double deduction IS allowed in a gift of appreciated stock or real property, since the appreciation that increases the deduction is not taxed. As your article implies, that is a special largess conferred specifically by the Code. Mark Weinberg, Maryland

Un-Gift

Thanks for the reminder that the value of a gift isn't necessarily tied to the tax deduction. Donor recognition is the other side of the value coin.

Un-gift

What are the gift tax consequences for the donor of a gift of the use of his property? Does this qualify for the gift tax charitable deduction?

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