Home Estate Planners Corner

Should Clients Maximize Charitable Deductions in 2010?

Income tax and capital gains tax rates are scheduled to go up in 2011, with or without further legislation in Congress.  The 33% and 35% brackets will move to 36% and 39.6% respectively, and the rate on most capital gains will increase from 15% to 20%.  Ordinarily, donors to charitable organizations save more from their deductions when tax rates are high, but there may be good reasons to make large contributions this year, not next:

• President Obama has proposed capping tax savings on certain itemized deductions (including contributions) at 28% for donors in the 36% or 39.6% tax brackets; 
• High-bracket donors may lose charitable deductions when the IRC §68 cutbacks on itemized deductions are reinstated in 2011. 

Contributions in 2010 face none of the above impediments, and may have favorable tax results unique to 2010.  For example, clients who convert traditional IRAs to Roth IRAs in 2010 ordinarily would report the resulting taxable income over tax years 2011 and 2012.  That may be less attractive with tax rates going up.  But clients have the option to report all Roth IRA conversion income in 2010, which would make even more sense if they can create large charitable deductions by accelerating charitable bequests, establishing charitable remainder trusts and gift annuities or contributing remainder interests in residences or agricultural property.

Mortgages Complicate Gifts of Real Estate

Real estate can be an attractive asset for charitable giving, but sometimes mortgages can get in the way.  Recently the Tax Court was asked about the effect of a mortgage on the contribution of a façade easement in historic property.

A façade easement is one type of qualified conservation contribution permitted by Congress, but under IRC §170(h)(1), a qualified conservation contribution must be a gift of a qualified real property interest, exclusively for conservation purposes, that is protected in perpetuity. 

A married couple had made a gift of a façade easement, but a bank held a mortgage on the underlying gift property, and had a prior claim to all proceeds in the event of condemnation.  Furthermore, the bank was first in line for all insurance proceeds resulting from any casualty loss.  The Tax Court ruled that the bank’s interest was “in preference” to the donee organization’s interest until the mortgage was satisfied, and consequently the easement was not enforceable in perpetuity – and did not constitute a qualified conservation contribution (Kaufman v. Comm’r., 134 TC. No. 9). 

Charitable transfers of debt-encumbered property can trigger at least three other adverse results:

• The bargain sale rules must be applied, which reduce the donor’s contribution deduction to his or her “equity” in the property and result in reporting of some capital gain by the donor (whose basis must be pro-rated between the gift portion and the outstanding debt, which is considered an amount realized by the donor).  See the discussion beginning on page 2-84 of the Charitable Giving Tax Service.
• Debt-financed (taxable) income may be realized by donee charity when it sells contributed real property, unless the donor had owned the property more than five years prior to the gift and the mortgage had existed more than five years.  In that case, charity won’t have debt-financed income if it sells within 10 years.  See the discussion on page 8-23 of the Charitable Giving Tax Service.
• Charitable remainder trusts that are funded with mortgaged property generally will be disqualified.  For a further discussion, and strategies for dealing with mortgage debt and charitable remainder trusts, see pages 7-104(u) to 7-106 of the Charitable Giving Tax Service.
  

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