Property Rights — and Wrongs

Donations of real estate can be extremely lucrative for charities, but they also can be more trouble than they’re worth

A handful of farmers in eastern Kansas were faced with a problem: They wanted to use their land, which had greatly appreciated in value, to set up planned gifts with charities in and around their hometown of Lenexa. The gifts, the farmers reasoned, would provide them with significant tax advantages and a continuing stream of income while also helping their favorite charities. But banks and other institutions were unwilling to accept the land as the basis for such gifts.

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So the donors and their financial advisers came up with a solution: They started a new charity, the Children’s Community Foundation, which won its tax exemption last year. The $25-million fund, created almost entirely from gifts of real estate, seeks donations to benefit children’s causes nationwide. The fund accepts real-estate gifts, oversees the sale of those properties, and invests the proceeds.

While few charities are as dependent on gifts of real estate as is the new foundation, many non-profit organizations are stepping up efforts to capture a share of the estimated $20-trillion worth of real estate now in private hands.

Some non-profit groups have begun to net millions of dollars annually from donated property. Last year, City of Hope, a Los Angeles cancer center, got $3.6-million from such gifts, while Wellesley College expects to realize more than $2-million this year.

Charities have grown more interested in seeking such gifts in part because the real-estate market has regained strength after having collapsed during the late 1980s to mid-1990s. The solid market is making it easier for many groups to turn donations of land into significant sums of cash.

And charity fund raisers see many potential real-estate gifts ahead as members of the World War II generation search for tax-savvy ways to pass on their homes and other properties — including vacation houses and investment properties such as apartment buildings or shopping centers — that they no longer wish to manage. Many of those properties have escalated sharply in value over the years.

Although many institutions have earned significant sums of money by selling donated real estate — or saved money by using donated buildings for charitable programs — some non-profit groups continue to shy away from such gifts because of the problems that can arise.

Charities can get into legal hot water, for example, if the donated property they try to sell is responsible for causing environmental damage. They also can find themselves in trouble with the Internal Revenue Service if they don’t accurately report the value of real-estate gifts. In addition, they can face problems with donors who try to exaggerate the value of their property in order to take a bigger tax deduction.

What’s more, some groups find that the repairs they have to make to some properties they put up for sale are so costly that the net gain is minimal — especially when the costs of professional legal and sales help are counted.

If charities manage to escape those problems, they often encounter other frustrations, such as disagreeing partners, liens, and zoning issues, to name only a few. About half of the real-estate donations that appear to be lucrative gifts on the surface turn out to be dead-end deals, says Robert Schweiger, a broker at Prudential Florida Realty, in Clearwater, who has been hired by several charities to look into potential real-estate gifts.

“I’ve completed at least 75 property gifts,” he says, “but I’ve checked out twice that many and turned them down.”

Another potential problem is that donors who give real estate often are very demanding, fund raisers say. “There’s a lot of handholding, often for weeks on end,” says Peter Doyle, director of planned giving at Wellesley College.

Many donors who want to give real estate are not motivated just by their desire to help charity, he says. “You’re often helping someone with a problem. These gifts are often the result of someone’s income needs, or they have problems selling and marketing the property.”

In some cases, Mr. Doyle says, donors mistakenly believe that his institution can solve their real-estate problems. “Some people think that we have magic dust because we are a fine liberal-arts college,” he says. “They think we’re going to take money from our endowment to help them sell their property.”

Communicating with such donors can be tricky, Mr. Doyle says, but explaining the charity’s objectives in accepting real estate can help.

“Donors have to put themselves in our shoes,” he says. “We always have to figure out how to turn the asset into money without losing money.”

Many potential donors have become increasingly sophisticated about financial planning and the tax and other benefits involved in disposing of real-estate holdings, financial advisers say.

Real-estate gifts are attractive to donors for several reasons. For one, they provide a charitable deduction for the value of the gift. What’s more, the donor does not have to wait until the property sells to take the deduction; the write-off can be taken as soon as the gift is made, provided that the amount falls within annual limits for deductions.

In addition, donors can avoid capital-gains taxes they would most likely face from selling the property. Some donors hope to avoid gift and estate taxes that would result if they left land or other property to their heirs.

Many donors use real estate to set up a deferred gift, which not only benefits charity but also produces an income for the donor and, in some cases, his or her heirs.

Such gifts are likely to become even more popular, experts say, because of new regulations adopted last month by the Internal Revenue Service. The new rules make it more financially attractive for people to use land and other non-liquid assets to set up a type of deferred gift known as a charitable remainder trust (The Chronicle, January 14).

Jim Normandin, executive vice-president of Memorial Medical Center Foundation, in Long Beach, Cal., which has raised more than $12-million from donated properties in the last three years, says many older donors are worried about whether their children will be able to handle a bequest of real estate.

Donors, he says, have come to wonder, “Should the kids get an apartment building with 30 units outright, or would they do better with a trust income instead?” He says he points out to potential donors that “by giving appreciated real estate, they can provide for charity and for the kids.”

Fund raisers who have been successful in raising money through real estate offer the following suggestions to prevent serious problems from arising:

Establish firm guidelines. Before accepting property, charities need guidelines on what types of real estate they can realistically handle, as well as a checklist of procedures that must be completed in each transaction, such as environmental inspections, market appraisals, site visits by staff members, and title searches, says Philip Purcell, director of development and planned gifts at St. Vincent Hospital Foundation, in Indianapolis.

Non-profit organizations can usually develop sound policies by involving chief fund raisers, the charity’s accounting office, its legal counsel, a lawyer who specializes in real-estate transactions, and members of the charity’s board, he says.

Start small. Charities have benefited from a wide variety of properties, including undeveloped land, shopping malls, and even recreational facilities, such as the $20-million ski resort that was donated to Harvard University in 1992. But many groups find it advisable to start with a small number of easier-to-handle properties.

“I try to get my colleagues to stay in the plain-vanilla area until they become more experienced,” says Frank McGrory, director of capital gifts and legal affairs at the Massachusetts Institute of Technology.

Some groups require donated properties to have a minimum market value, such as $100,000, be confined to a certain geographic region, and be owned outright or be no more than 25 per cent indebted.

Another aspect that charities should consider in drafting guidelines is the type of ownership involved, real-estate experts note. Donors sometimes say they own real estate when in reality they have a partner or they own shares in a limited partnership, which in turn owns the property. While such forms of ownership do not necessarily rule out a gift, they do greatly complicate transactions, experts say.

Be prepared to walk away. Mr. Doyle of Wellesley College recalls one problematic gift: a $250,000 home that a couple wanted to live in until their deaths, after which it would be sold and the proceeds divided among the college and a handful of other charities. In addition to the complications of working with the other charities, says Mr. Doyle, an inspection revealed that the house was built on top of red coal, a soft substance that could break down over time, causing structural problems in the house.

The potential time and expense of correcting the problem and working with several other organizations — in view of how much money Wellesley would ultimately get — caused Mr. Doyle to turn the gift down.

“I was already fast forwarding to the year 2011 when the donors pass away,” says Mr. Doyle. “Split between so many charities, the net value of that gift would only be about $30,000 for us. Given everything we’d have to do, it was just not worth it.”

Get professional help. “You cannot just have someone who’s doing the annual fund and capital campaigning on staff who’s also handling real-estate gifts for the charity,” says Mary Goodell Hayakawa, director of property management at City of Hope. “You either need a real-estate expert on staff who does this full time, or you need one or more outside consultants who understand real-estate gifts,” she says. “Sometimes you need both.”

Ms. Hayakawa, a tax lawyer with a background in trusts and estates, was selected by City of Hope to work in a real-estate division that it formed in 1992. Officials realized that, with all the money they were spending on real-estate consultants, it would be cheaper to have an in-house department.

City of Hope currently has a staff of five — two lawyers and three administrative employees — who concentrate solely on real-estate gifts. They provide the necessary expertise to other fund raisers who identify people who could make real-estate donations.

Ask careful questions. When charities hire outside experts like real-estate brokers, they frequently ask the wrong questions, says Chase Magnuson, vice-president of Carr Real Estate Services for Charities, a Santa Ana, Cal., division of CarrAmerica, a national realty company.

“I’ve seen charities just go to a broker and ask if they can handle commercial real estate,” says Mr. Magnuson. “Of course the broker is going to say Yes. You need to know a lot more than that.”

A medical-office building, for example, requires an entirely different broker than one who simply sells office space, says Mr. Magnuson. The broker, among other things, must be able to answer questions on whether particular types of medical equipment can be accommodated or added.

Mr. Magnuson says that charities should seek brokers who have sold several properties that are very similar to the one offered by the donor and are in the same geographic area.

Be wary of appraisals. Appraisals are required procedure with any real-estate gift, but the appraised value should never be regarded as the amount the charity will actually get, experts warn.

“The appraisal is capable of wide variation — it can be very misleading,” says Douglas Freeman, a Los Angeles lawyer who specializes in estate planning and other planned-giving issues. “Even with the best appraisal, you have to be cautious, because the real-estate market can change.”

Early on, charities should compare the appraised value to an estimated market value provided by a knowledgable broker, says Mr. Schweiger of Prudential. “If there’s a big disparity, say more than 10 to 15 per cent,” he says, “you’ll probably have trouble.”

A common reason for such disparities is that the appraisal the donor wants to be used to determine the value of the gift — an appraisal that is often paid for by the donor — is either inflated or outdated, experts say. In some cases, donors want a large tax deduction and are convinced that their property is worth more than it really is.

“Everybody remembers what they could get for their house in the ‘80s, and they are really stuck on that,” says Ms. Hayakawa of City of Hope. “I’ve seen cases where a house was worth $500,000 but now it would bring only about $250,000.”

Many experts advise that charities get a current, independent appraisal of the property to be donated. Charities that accept inflated appraisals could find themselves in trouble with the I.R.S. if the tax agency found that the organizations had aided a donor in taking a bigger-than-deserved deduction.

Be skeptical. “Everybody says they have a great real-estate deal for me, but I don’t believe that anymore,” says Ms. Hayakawa of City of Hope. A couple might say that they have $4-million in real estate, she says, “but then you find out that there is a toxic-waste problem, and they forgot to tell you that they filed for bankruptcy.”

Ms. Hayakawa says that, with every potential real-estate donation, she tries to find out why the person wants to make the gift.

“It’s one thing if they are getting older, they do not want to manage the property anymore, it has little or no debt, and their husband was treated for cancer here,” she says. “But what if the property has been listed for 10 years, is co-owned by a partner they no longer speak to, and it’s an office building with a 40-per-cent vacancy rate? That’s a gift I probably don’t want.”

Adds Ron Peters, a Saratoga Springs, N.Y., commercial real-estate consultant who works with donated properties: “Make sure you know who the donor is, get some background on them. If they get audited, you might be too.”