Having Your Cake and Eating it Too – Donating Residual Interests
Adam Aptowitzer, December 13, 2007
Most people who are familiar with the donation of property to charity do not realize that the bundle of rights that comes with the ownership of property can be divided in different ways. One of the ways to do this is to divide ownership of the property during one’s life (called a life interest) from ownership on the death of that person (called a residual interest). This is different from a property owner who owns the property and on death uses a will to dispose of the property in a manner he or she sees fit. A donor might consider this course of action in situations where the owner wants to enjoy the income or use of the property during their lifetime and yet donate the property to the charity during their lifetime.
In situations where it is difficult to record the division of interests on title, planners can use trusts such as charitable remainder trusts to donate an interest in the property. In these situations, the donor disposes of the residual interest to the trust and then donates the entire interest in the trust to the charity. It is important to note that the donation in this case occurs when the owner transfers the interest in the trust to the charity. Thus, if the underlying property is publicly traded securities, the gift of an interest in the trust will not attract the same favourable tax treatment as donating the securities would have.
The value of the residual interest is calculated using an estimated value of the underlying property at the expected death of the donor (in itself determined from actuarial mortality tables) using present value dollars. This amount will be the value listed on the charity’s receipt. Determining the fair market value of a property at the expected death of the owner at some point in the future is a complicated mathematical task best left to a qualified actuary.
From a tax perspective, when the owner divides the rights and disposes of (i.e. gives away or sells) the residual interest, the former interest owner would generally incur a tax consequence. The tax owing will be a function of the cost of purchasing those rights and their value at the time of their disposition.
Generally, there will be tax on the disposition of the residual charity (unless the property is, for example, a principal residence or ecological property being donated to an ecological charity). The capital gain is calculated according to a specific formula and depends on the gain in value of the residual interest relative to the entire property.
The charity may want to make a notation on the title deed of the property indicating that it owns the residual interest, but even if the property is real estate not every jurisdiction allows this. It will also likely want to ensure that the gift qualifies as a “ten year gift” otherwise the entire amount on the receipt will fall into the charity’s disbursement quota in the year following the gift even if it does not actually receive the property until the death of the life interest holder. Of course, there are still disbursement quota obligations that come with ten-year gifts and the charity will need to ensure that it can meet these obligations before accepting the gift.
These complicated transactions require the advice of lawyers who are experienced in this area. If you have any questions about donating residual interests or using charitable remainder trusts, please contact the author at firstname.lastname@example.org