Gift Planning Tips

Defective, on Purpose

Assets in inter vivos charitable lead trusts can revert to the donor or pass to family members when the trust ends.  If assets revert to the donor, an income tax charitable deduction is available.  The downside: the trust is a grantor trust [Code §§671-677] and the donor is taxed on trust income.  No income tax deduction is available when assets pass to younger family members under a nongrantor trust, although transfer tax costs can be reduced with the gift tax charitable deduction.  The donor is not taxed on trust income and the assets are removed from the gross estate.

It’s possible to receive both an income tax and a gift tax charitable deduction by creating an intentionally defective grantor lead trust.  When the trust ends, assets pass to family members, but because the donor has included certain powers in the trust, it is a grantor trust for income tax purposes.  The retained power is not sufficient to cause the value to be included in the donor’s gross estate.

Giving a nonadverse third party the right to substitute property of equal value for trust assets will make the trust a grantor trust (e.g., Letter Rulings 9224029, 9642039), as will giving an independent trustee the power to add one or more charities to the class of beneficiaries eligible to receive trust distributions at its termination (Letter Ruling 199936031).

Donors may receive deduction tax savings in a 39.6% tax bracket but pay tax on future trust income at rates of 20% or less.  The trust works best if it is funded with municipal bonds or growth securities that pay little or no dividends.  The trustee can liquidate just enough stock to satisfy the charitable obligation each year.

Save by Giving

Code §121(b) allows a $250,000 capital gains exclusion on the sale of a principal residence ($500,000 for married couples).  The home must have been owned and used as the taxpayer’s principal residence for at least two of the prior five years.  The full exclusion is available only once every two years [Code §121(b)(3)(A)].  This provision is designed to allow homeowners to avoid tax on the appreciated value of the home upon a sale.  What if a client’s home has appreciated beyond the exclusion levels?

One way to reduce the gain may be to give charity an undivided interest in the home prior to a sale.  A portion of the donor’s basis will be allocated to the gift portion, but the amount received by the donor may fall within the exclusion limit.  In addition, the donor will be entitled to a charitable deduction for the value of the undivided interest.

A Deduction for "Doing Nothing"

Many people complain about urban sprawl, but certain donors do something about it — and get a charitable deduction to boot [Code §170(h)(1)].  Under Reg. §1.170A-7(b)(1)(ii), a grant to charity of an open space easement in perpetuity is an exception to the partial interest rule.  Such easements are often made to governmental agencies, but may be made to any qualified charity capable of enforcing the restrictions contained in the easement.  Easements may also be granted to preserve scenic views.  The donor is free to use the land or sell it, subject to the restrictions in the easement.  A charitable deduction is allowed for the diminished value of the property.  Generally, a before-and-after approach is used to determine value.

A special estate tax charitable deduction is also available for a conservation easement, up to a maximum of $500,000 [Code §2031(c)].   Clients with property in ecologically sensitive areas may be interested in assuring that the land is not developed, while also securing for themselves a charitable deduction through a grant of a perpetual easement.

Giving Authority to Give

The IRS and courts have generally taken the position that, unless an attorney-in-fact under a durable power of attorney has the specific authority to make gifts, the transfers do not qualify under the annual exclusion [Code §2503(b)] and may be brought back into the gross estate at the owner’s death as revocable transfers [Code §2038] (e.g., Estate of Casey v. Commissioner, 948 F.2d 895; TAM 9342002; Letter Ruling 9509034).

Advisers and clients should consider whether it’s appropriate for the attorney-in-fact to make charitable gifts, as well as gifts to family members.  The client might want to limit the gifts to certain organizations or individuals, or place a cap on the amount that can be given – the annual exclusion amount in effect for the year, for example.  Giving the authority to make gifts may permit greater flexibility in reducing transfer taxes, including the ability to make split-interest gifts to benefit the owner or other family member.


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