10. Gifts of Partial Interests, Part 3 of 3

10. Gifts of Partial Interests, Part 3 of 3

Article posted in General on 18 April 2016| comments
audience: National Publication, Russell N. James III, J.D., Ph.D., CFP | last updated: 27 April 2016


Russell James completes his detailed section on gifts of partial interests.

An Introduction to the Law and Taxation
of Charitable Gift Planning

By: Russell James III, J.D., Ph.D.


Links to previous sections of book are found at the end of each section.

Given that these rules must be followed over a 10 year period of time, it is reasonable to ask what happens if the donor fails to transfer the rest of his interest to charity within the 10 year time?  Or, similarly, what happens if the donor dies prior to the end of the 10 year period, and the estate does not give the remaining interest to the charity?

Violating the rules for gifts of fractional shares in tangible personal property results in recapture.  Specifically, all previous deductions are now counted as ordinary income.  The donor must pay the taxes on this ordinary income, plus interest, plus a 10% penalty on the taxes owed.  The result of recapture is sufficiently unpleasant to deter taxpayers from taking this deduction without completing the ultimate transfer of all rights to the charity within 10 years.
We have seen how a donor who retains specific types of interests in property and gives other types of interests to charity makes a nondeductible gift of a divided share in property.  However, is there a case in which a donor may contribute less than the complete ownership rights (i.e., a partial interest) to the property and still deduct the gift?

The donor is allowed to deduct the gift of a partial interest in property if the donor does not retain some other type of interest different from the type of interest given to the charity.  So, to return to the walnut tree analogy, suppose that the donor does not own a walnut tree, but instead owns only the rights to walnuts from specific tree branches.  The donor may contribute all of his rights in the specific tree branches to a charity and receive an income tax deduction.

Why is the donor allowed to deduct such a gift of partial interests to a charity?  The reason for the prohibition against partial interest gifts to a charity where the donor retains some different type of right is to prevent the donor from increasing the value of his retained interest while decreasing the value of the interest held by the charity.  In this case, if the donor gives everything that he owns (or a share of everything that he owns), then there is no risk of the donor increasing the value of the type of right that he has retained and simultaneously decreasing the value of the type of right that the charity owns.  If the donor gives everything that he owns, he is retaining no rights in the property, thus eliminating the risk of this conflict.  Similarly, if the donor gives a share of all of the interests he owns (even if he only owns partial interests), there is no way for the donor to increase the value of his interests while decreasing the value of the interests given to the charity.  Consequently, these transfers are deductible.

Suppose a donor gives farmland to a charity.  However, the donor never owned the mineral rights to the land.  Thus, the donor is giving a partial interest in the land to a charity.  Is this gift deductible?
This gift is deductible because the donor is giving all of the rights he owns to the property.  Whenever the donor gives all of the donor’s interests in the property, there is no retained interest and consequently the gift may be deducted.
Suppose instead of giving the farmland to a charity, the donor gives a 5% interest in the farmland to the charity.  As before, the donor never owned the mineral rights to the land.  Is this a deductible gift?
This is a transfer of an undivided share of all of the donor’s interests in the property.  Consequently, this is a deductible gift.  The donor is not retaining any types of rights different from the types of rights given to the charity (although the exact ownership percentages differ).

This next transaction shows how these rules can be combined to generate creative and useful transactions.  In this case, the donor begins by giving the charity the right to own his vacation home after he dies using a remainder deed (the remainder interest).  The donor retains the right to use the property for the rest of his life (the life estate).

Although dealt with in a separate chapter, remainder interest gifts in a personal residence (with a retained life estate) are deductible as a specific exception to the general rule against deductions of partial interest gifts where the donor retains different types of interests.  The total ownership rights to a property consist of the life estate (right to use during life) and the remainder interest (right to own after death).

After this transaction, the donor’s only remaining interest in the property is the right to use it for the remainder of his life.  This right to use is called a life estate.  The donor then gives an 11/12 interest in his life estate, keeping the right to use the property for one month out of the year.  This gift is deductible because it is an undivided interest in all of the rights still owned by the donor.  Through this series of transactions, the donor has been able to transfer and deduct all rights to the property, excepting only the lifetime right to use the vacation home for one month of the year.  Depending upon the donor’s age, this type of transaction could easily result in deductions of 95% or more of the value of the property.  If the donor’s use of the property had been to occupy it for only one month out of the year anyway, this massive deduction comes without changing the donor’s lifetime use of the property.

Note that if the donor had given an 11/12 interest in a life estate to the charity before giving the remainder interest, this would not have been a deductible gift.  In that case, the donor would have been retaining a different type of right (the remainder interest), than the type of right given to the charity (a life estate).  And, there are no special exceptions for gifting life estates as there are for gifting remainder interests.  But, because the donor did not make the gift of the 11/12 interest in a life estate until after his only interest in the property was a life estate, the transfer is deductible.  At that point, the donor is giving an undivided share of all of the donor’s interests, because the donor’s only remaining interest is a life estate in the property.
Partial interest gifts are also allowed if all of the donor’s interests are transferred to different charities.  As before, the concern is not with deducting the transfer of a partial interest to a charity, the concern is in allowing this deduction when the donor simultaneously retains different types of rights to the property.  Such a concern does not apply here, because the donor keeps nothing for himself.  It is thus perfectly acceptable to give a variety of different partial interest gifts to different charities when the donor retains no rights to the property. 
As an example of this, if a donor were to give underlying ownership of farmland to the Red Cross, but give the mineral rights in the farmland to the Salvation Army and also give rent-free use of the property for 10 years to his local church, this would constitute a deductible gift of all the donor’s interests in the farmland.  Consequently, the donor could deduct the full value of the farmland, even though the ownership rights were split among multiple charities.
The bottom line result is that donors will get no deduction if they keep any type of rights that are different from the type of rights given to the charity.  In other words, the donor must give or share all of his rights, or there is no deduction.  The specific exceptions to this general rule (Charitable Remainder Trusts, Charitable Lead Trusts, Pooled Income Funds, remainder interest with retained life estates in homes or farmland, and qualified conservation easements) will be addressed in other chapters.
As we end this chapter, it might be useful to note that gifts of partial interests in property through the designated exceptions constitute the bulk of all planned giving structures.  Allowing a donor to make a transfer to charity, but still keep some rights in the property is a technique which can allow the donor to make a charitable impact even in cases where he or she still has some needs from the property.  This splitting of rights can create a fundamental benefit of planned giving: showing a donor who says, “I wish I could do more, but…” that it is possible to both benefit the charity and accomplish the donor’s other financial goals, even when traditional outright gifts are not feasible.

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