Donate Your House to Charity

Sometimes in life you cannot have your cake and it too. 

The following case addressed a family's attempt to donate their home to a local fire department and the accompanying tax consequences.

Rolfs v Commissioner (7th Cir 2012) 668 F3d 888

The Rolfs purchased a lakefront property on Pine Lake in Chenequa, Wisconsin. The Rolfs were dissatisfied with the existing home and decided to donate the home to the local fire department for training. The fire department, not surprisingly, burned down the house in a subsequent exercise. The Rolfs then claimed a $76,000 charitable deduction on their 1998 tax return for the donated home. Their theory was as follows "[t]he taxpayers argued that the "before-and-after" method should be applied. Their appraiser started with an estimated value of $675,000 for the land and house together, based on comparisons to recent sales of similar properties in the area. Using the same method, he estimated a value of $599,000 for the land alone, without any house on it. He subtracted the latter from the former to estimate $76,000 as the value of the house alone." 

The IRS was dissuaded with this claim and rejected it. The Rolfs then lost on appeal to the Tax Court and appealed again to the circuit court of appeals.

The appellate court affirmed, finding that when donated property is subject to a condition, the condition needs to be accounted for when making the property valuation. In other words, if a donation has strings attached, you need to factor the strings into the valuation equation. In this case, a donated home, given on the condition of subsequent incineration, has practically no value. Trust me on this one.

Furthermore, the appellate court affirmed the finding that the Rolfs received a benefit of $10,000 by donating their home to the fire department. Since the old home would invariably be razed to make way for the new home, this donation essentially benefited the Rolfs aside from the charitable deduction because the fire department performed the necessary destruction of the home. Thus, if the Rolfs' deduction was upheld, the benefit to them would be twofold. First, they would receive a charitable deduction for their donated home. Second, they would avoid having to pay somebody to tear down their home. 

On the bright side, the donation saved the Rolfs the trouble of finding a company to apply a wrecking ball to their home. Hence the latter benefit remained intact despite the court's ruling, the home destruction by the fire department, while the former benefit, the charitable deduction, was disallowed.

Living Trusts Taxation

The following is an excerpt from a recent California Court of Appeal decision:

"Before Beckwith presented the will to MacGinnis, he called Dahl to tell her about the will and e-mailed her a copy. Later that night, Dahl responded to Beckwith's e-mail stating: `"I really think we should look into a Trust for [MacGinnis ]. There are far less regulations and it does not go through probate. The house and all property would be in our names and if something should happen to [MacGinnis] we could make decisions without it going to probate and the taxes are less on a trust rather than the normal inheritance tax."

Beckwith v. Dahl (2012) ___ CA4th ___

The phrase in italics is a common fallacy held by many people. A revocable trust is a tax neutral document, i.e. it will neither increase nor decrease taxes.  Dahl was acting under this erroneous belief when she emailed Beckwith above. Regardless if the decedent wrote a will or revocable trust, the taxation of their estate would be unaffected by the drafting of either instrument. The principal reason for this is because reducing or eliminating the estate tax, "inheritance tax" is a colloquialism, is determined by the recipient of the property, e.g. a spouse or a charity, as opposed to what instrument is used.

However, it should be noted that other types of trusts are created to avoid or reduce taxes. For example, a disclaimer, A/B and charitable trusts are all examples of trust specifically designed for such. Still, each of these trusts utilize beneficiaries that are considered allowable deductions for estate tax purposes. For example, if a person passes away with a $100M estate, they can devise it entirely to charity and their estate will not have any estate tax liability.

Estate Tax in 2012

Since the end of the year is very much upon us, this brings changes to tax law. In particular, the Estate Tax is set to be changed, albeit ever so slightly, in 2012.

1. What will be the federal Estate Tax limit in 2012?

The federal Estate Tax limit in 2012 will be $5,120,000. This was announced by the IRS on October 20, 2011.

2. What was the federal Estate Tax limit in 2011?

The federal Estate Tax limit was $5,000,000 in 2011. When the prior Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, the exemption amount was increased to $5M in 2011 and would be indexed for inflation in 2012. The $120,000 increase for 2012 reflects that.

3. What about the California Estate tax in 2012?

There is no California Estate Tax in 2012 for people who pass away after December 31, 2004.

The topic of the California Estate Tax is very popular apparently. It was easily the most commonly used keyword to reach my blog in 2011. For instance, "California estate tax 2011" was used 1,495 times to  reach my blog and "California inheritance tax 2011" was used 767 times to reach my blog.

4. What does the Estate Tax limit mean?

The figures just mentioned represent the threshold amount before tax is owed. For example, if a person passes away with an estate worth $300,000 in 2012, then no Estate Tax is due. However, if the person is worth $100M when they pass away in 2012, then it is likely that the estate will have to pay the Estate Tax. It is not a certainty however that a very affluent individual will be liable for the Estate Tax as there are deductions a person may make to avoid the Estate Tax. For example, it is quite common for the rich (or 1% for you Occupy Wall Street sympathizers) to leave a sizable portion of their estate to charity which thereby avoids the Estate Tax if the donation is large enough. IRC §2055(a).

5. Which year's Estate Tax law applies to a particular estate?

The laws in effect when a person passes away is the applicable law. For example, if a person passes away in 2011, the the limit is $5M, if a person passes away in 2012, then the limit is $5,120,000.

I have been asked on multiple occasions whether or not the year in which the trust or will was written dictates which Estate Tax law applies. No, it does not. Although it is easy to see why a person would want such a scenario. If the Estate Tax was changed, hypothetically-speaking, to a $3M exemption for 2013, people would obviously prefer to have either the 2011 or 2012 law apply because of the greater exemption limit.

Conversely, if you are inclined to leave the IRS your money, despite the inapplicability of the Estate Tax, you may due so by sending a check to the following address:

Attn Dept G
Bureau of the Public Debt
P. O. Box 2188
Parkersburg, WV 26106-2188

6. What does the future hold for the Estate Tax?

The current Estate Tax system is set to expire in 2013 and the exemption amount will revert back to $1M then. Consequently, the next election in November 2012 will greatly impact the specifics of the Estate Tax. Democrats are inclined to lower the Estate Tax limit and Republicans are inclined to increase or possibly abolish it. Thus, the victor in 2012's elections will have the opportunity to craft future Estate Tax legislation.   

Charitable Deduction - Estate Tax

Americans in general are a charitable lot. Millions of Americans annually donate to community, religious, civic and athletic organizations that operate as charitable organizations. There is an immediate tax benefit to this, the charitable deduction the donor can take on their annual tax return during one's lifetime. Conversely, even at one’s passing, there is a tax benefit to donating to charity, namely a deduction on their estate tax. The following are some questions that provide a broad overview of the topic.

1. What is the charitable deduction in the context of the estate tax?

Federal law allows a U.S. citizen or resident of the United State to leave some or all of their estate to a qualified charitable organization which will reduce their estate tax liability. IRC §2055(a).

For example Danny Decedent was a resident of Campbell, CA. At the time of his passing in 2011, Danny had earned a vast fortune because he was an early investor in Google, namely $12M. Danny was concerned about paying Uncle Sam millions of dollars in estate taxes at his death, as the tax rate for estates larger than $5M was 35%. IRC §2010(c). Danny had engaged in philanthropic endeavors during his life and wanted to benefit these charities rather than have his money be sent to Washington D.C. Therefore, Danny decided to leave his entire estate to two California-based charities, HealthCare Volunteer and CACS Government Research, via his will.

Editor’s Note: The person is fictionialized while the charities are authentic.

2. What types of charities are eligible beneficiaries?

Federal law says the following charities are eligible: (1) The United States, any state, any political subdivision thereof, or the District of Columbia, but only if the contribution is used for exclusively public purposes, (2) IRC §501(c)(3) organizations established in nonprofit corporation form, (3) IRC §501(c)(3) organizations established in charitable trust form, (4) various veterans' organizations or (5) employee stock ownership plans subject to certain conditions. IRC §2055(a).

(2) and (3) are the most common beneficiaries for reference. For example, thousands of people have left money to their university or graduate school which falls under the category of (2) and (3).

3. What happens if a donor receives something in return for the donation?

When a donor receives something in exchange for their donation, a quid pro quo basically, the value of the goods or services generally offsets the value of the contribution for tax purposes. Treas Reg §1.170A. For instance, assume a late donor gives $100,000 to their beloved alma mater, San Diego State University for example, and SDSU replies by giving the late donor’s grand niece an athletic scholarship worth $40,000. Generally speaking, the donor’s estate could only claim a $60,000 charitable deduction on the estate tax return. (IRS Form 706 for those curious).

4. Is there a limit on the charitable deduction for estate tax purposes?

Federal law does not limit the estate tax charitable contribution deduction that can be claimed. IRC §2055. Thus, a person is free to leave their estate to a charity to avoid paying any estate tax. For instance, noted multi-billionaire Bill Gates may leave his entire estate, something in the range of $56B, to a charitable organization to avoid the estate tax.

5. Is it common to leave an estate to charity?

From my experience, few clients leave their estate to charity. In particular, the select few who do leave money to charity usually allocate a small fraction of their estate to charity rather than their entire estate. Individuals who leave vast amounts to charities are often the very wealthy who face an estate tax issue. This should by no means dissuade anybody from thinking about giving to charity. It is just that many parents have a sense of obligation to provide for their children. In contrast, the very wealthy do not really have that concern because their children are taken care of already. Hence, the former often leaves their estate to their spouse and children whereas the latter leaves it charity typically.

6. Are there trusts for this?

Yes, there are trusts specifically designed to achieve a charitable estate tax deduction. Examples of these include a charitable lead trust and a charitable remainder trust.