EXIT STRATEGIES THE CHARITABLE CONTRIBUTION OPTION

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EXIT STRATEGIES THE CHARITABLE CONTRIBUTION
OPTION

• on behalf of the not-for-profit
• Kansas Heritage Foundation
• Spring 2006

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INTRODUCTION

• High income individuals generate large portfolios
  of property and asset investments
• Over time, many desire to dispose of certain
  assets for simplification, to stop cash outflows
  for property taxes or fees, or just because life
  has taken a different direction
• Certain assets may be creating or adding to a
  negative income tax impact
• Other assets may be offered for sale, but a
  willing buyer is not readily available

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AN EXAMPLE PROBLEM

• Apartments developed in 1980s
• Accelerated depreciation created losses
• Depreciation gone, profits now while debt
  continues to be paid
• Limited cash distributions (in govt program)so
  cannot fund tax liability
• Large past losses created negative capital
  balances-- must recapture in income if sold

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RECAP

• 15 year old building
• 35 years of mortgage debt to pay
• Loss stream abruptly turned to income
• No cash to pay tax
• Cant walk away without income recapture

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WHY DO WE HAVE THIS PROBLEM?

• Original IRS intent was income deferral, not
  avoidance
• Must cash flow now (creating taxable income) to
  pay debt, even though depreciation gone
• Depreciation rules changed new owners dont
  enjoy large losses in early years (27.5 year
  straight line life vs. 15 year accelerated)

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WHAT ARE YOUR EXIT OPTIONS?
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WHAT ARE YOUR EXIT OPTIONS?1. Dont exit.
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WHAT ARE YOUR EXIT OPTIONS?1. Dont exit.

• Keep property and pay tax on passive income
  generated over remaining 35 years of the
  mortgage.

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WHAT ARE YOUR EXIT OPTIONS?1. Dont exit.

• Keep property and pay tax on passive income
  generated over remaining 35 years of the
  mortgage.
• Why give up and pay the tax?

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WHAT ARE YOUR EXIT OPTIONS? 2. Give your
interest away.
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WHAT ARE YOUR EXIT OPTIONS?2. Give your
interest away.

• Give your interest to someone whose tax impact of
  the income recognition is minimal.

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WHAT ARE YOUR EXIT OPTIONS?2. Give your
interest away.

• Give your interest to someone whose tax impact of
  the income recognition is minimal.
• May work in limited situations, but you must be
  willing to forfeit the underlying asset.

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WHAT ARE YOUR EXIT OPTIONS?3. Die with the
interest.
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WHAT ARE YOUR EXIT OPTIONS?3. Die with the
interest.

• Sooner rather than later . . .

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WHAT ARE YOUR EXIT OPTIONS?3. Die with the
interest.

• Sooner rather than later . . .
• To receive a step up in basis.
• But who wants to hope for this?

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WHAT ARE YOUR EXIT OPTIONS?4. Find buyer
willing to pay for property.
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WHAT ARE YOUR EXIT OPTIONS?4. Find buyer
willing to pay for property.

• Find a buyer willing to pay enough for the
  property to cover tax liability from the
  disposition.

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WHAT ARE YOUR EXIT OPTIONS?4. Find buyer
willing to pay for property.

• Find a buyer willing to pay enough for the
  property to cover tax liability from the
  disposition.
• Wont cash flow for buyer If one found, subject
  to lender approval.

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WHAT ARE YOUR EXIT OPTIONS?5. Walk away from
the interest.
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WHAT ARE YOUR EXIT OPTIONS?5. Walk away from
the interest.

• Pay tax on the disposition unless you have
  suspended loss carryforwards available to offset.

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WHAT ARE YOUR EXIT OPTIONS?6. Contribute
interest to a qualified charity.
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WHAT ARE YOUR EXIT OPTIONS?6. Contribute
interest to a qualified charity.

• The charitable deduction softens the tax impact
  of the disposition and is an opportunity to
  benefit organizations helping others.

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MECHANICS OF A CHARITABLE CONTRIBUTION

• A. Identify the interest to contribute, is it
• 1. Real estate
• 2. Stock
• 3. Business interest
• 4. Yacht
• 5. Other

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MECHANICS OF A CHARITABLE CONTRIBUTION

• B. Calculate tax impact of disposal
• Negative tax capital account is tentative gain
• Use estimated appraisal to calculate bargain sale
  basis adjustment
• Reduce this adjusted gain by any passive loss
  carryforwards
• Tax projection addl income vs. charitable
  contribution (appraisalgtdebt)
• Tax consequences are fact specific to each donor

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MECHANICS OF A CHARITABLE CONTRIBUTION

• C. Weigh any immediate cost against eliminating
  the future taxable income (or out-of-pocket
  expense) stream

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THE BIGGEST CHALLENGE????

• Identify a qualified charity willing to accept
  the interest donated
• Identify a charity able to accept the property
  without causing UBTI to the charity

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THE BIGGEST CHALLENGE????

• Jerry proceeded through the previous analysis,
  but was continually frustrated trying to locate a
  charity willing and able to accept properties.

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THE SOLUTION

• Jerry worked with others to create one
• Some are intentionally structured to be able to
  accept specific types of assets or property
• A solid charity with a strong underlying purpose
  is key - must be legitimate
• Not easy, quick or inexpensive to establish your
  own
• Kansas Heritage Foundation

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NFP KHF

• Benefits Students in Free Enterprise working
  with interns from the United States and other
  countries
• Can accept all types of property from real
  estate to stocks to businesses to yachts
• Has management company in place willing to accept
  management responsibilities other entities wont
• Depending on specific situation, may be able to
  structure transaction with cash out to donor
• Appraisal process assistance

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THE IMPORTANCE OF A GOOD APPRAISAL

• 1. Qualified knowledgeable appraiser
• 2. Specific property appraisal (USPAP 2)
• 3. Satisfaction of IRS requirements
• 4. Certification of value on IRS Form 8283

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QUESTIONS

• Concerns
• or
• Specific Questions?

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CLOSING

• Review your asset portfolio and determine items
  you wish to transfer (may be tax motivated or
  not)
• Study exit options list for sale, locate buyer,
  negotiate price fees
• Consider the charitable contribution option a
  win-win solution

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THANK YOU