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The information below can be impacted by regional legislation and other unique variables. For the real deal, always consult with a qualified legal professional before taking action.
When I got into the niche of land investing, I was pleasantly surprised to learn that it's not difficult to buy properties for pennies on the dollar.
As with anything, when you're looking in the right places and talking to the right people, almost any process can be made easier and more efficient – and real estate investing is no exception.
To my surprise, I found that getting my properties sold was a bigger challenge than buying them cheaply in the first place.
Part of the problem is that I'm not the most patient person. When I list a property for sale, I want it sold today. Not next week. Not next month. Not next year.
In some cases, I got lucky and my properties actually did sell in a matter of days – but more often than not, it took at least a month or two to move my inventory, and every once in a while, I found myself stuck with a property that just wouldn't freaking sell.
Whenever I was dealing with one of these stubborn properties (i.e. – listings that sat on the market for more than three months), I would always remember a saying my dad used to say…
“There's more than one way to skin a cat.”
Have you ever heard those words before? It's meaning is simple…
Even though we may have a preconceived notion about how something is supposed to be done, there's almost always an alternative route that will accomplish the same goal.
Granted – sometimes the alternative is more difficult…
Sometimes the alternative is more complicated (hence the reason why nobody does it)…
But every once in a while, the alternative is actually easier than the conventional route we're all accustomed to. The only reason nobody does it is that it's not an obvious solution.
Case in point…
Let's look at a very real scenario I dealt with in my first year as a land investor.
Back in late-2008, I bought this vacant lot for $4,000:
I'll be honest with you… I overpaid for the thing, BIG TIME.
The county assessor had given this property an assessed value of $5,000, which meant that by their standards, the property was worth $10,000 (each state handles assessed values differently – but in my state, assessed values are approximately 50% of a property's supposed market value).
At the time, what I didn't realize was that most county offices are renowned for over-shooting on these property values.
Why? Because when they value properties higher, they can also charge more in property taxes each year. Think about it… when you have the power to establish values AND handle the taxation on each property, wouldn't you be more inclined to air on the higher side too?
At the time, I figured this assessed value was actually reliable (big mistake), so I offered 40% of this value (which is on the higher side of my equation).
About 4 months later (which seemed like an eternity at the time), I found a buyer who paid me $4,900 for it. Given how much money and time I had sunk into this property, how hard I worked to sell it, and how small my payday was in the end, I wasn't thrilled with the results on this deal. Had I been more patient, I probably could have done better, but I was so paranoid and eager to get it sold that I let my impatience get the best of me.
What I didn’t know at the time, was that I could just as well have donated this property to an eligible non-profit organization and treated it as a tax write-off, which would have effectively given me a lot more “after-tax income” in the end. As long as the tax prep system you use is up to date, it should be set up to account for this.
Donating Land? Seriously??
At first glance, some people may think the idea sounds ridiculous – but it's not all that different from what many of us do all the time with other things we own.
Have you ever donated old clothes, toys, or furniture to a second-hand store? Ever given a tithe for a church offering? Perhaps you've felt moved to sponsor a child in need or give canned goods to a homeless shelter? Some people even donate their old cars, boats, and equipment and receive tax deductions in return.
What most people don't realize is, you can follow the exact same strategy with real estate and the real kicker is – in some cases, you can come out even further ahead if you give your properties away instead of selling them the conventional way!
As long as you can document the transaction and verify the numbers in sufficient detail – you can donate your properties and receive credit for their FULL market value (regardless of how little you paid for it).
This is a big deal – and when you're able to buy properties for pennies on the dollar, this little-known strategy can go a long way towards reducing your tax bill (or even eliminating it altogether). In the same way, you can supercharge your retirement savings tax-free, you can also create some HUGE tax write-offs by selectively donating properties instead of selling them for cash.
How to Donate Real Estate
I had heard about this strategy years ago but was a little foggy on the specifics of how it works, so I spoke with three different CPAs in my area, along with three licensed real estate appraisers to get the low-down on what procedures need to be followed in order to do this right.
Disclaimer: I'm not a CPA or an appraiser and as such, I'm not qualified to give you any deal-specific tax advice. I know nothing about your financial situation, I'm not familiar with the local laws in your area and I have no idea what kinds of properties you're working with… so before you move forward with the steps outlined below, do us both a favor and cross-check these procedures with a tax pro in your area.
Step 1: Find an eligible non-profit organization that is willing to accept your property.
There are millions of organizations out there that carry “non-profit” status, but only certain types of non-profits can accept contributions that will qualify as a legitimate tax write off for the donor (i.e. – you).
- Religious (churches, mosques, synagogues)
- Educational (schools, colleges)
- Scientific (research facilities)
- Charitable (homeless shelters, child sponsorship)
- Literary (libraries)
- Public Safety (community improvement)
- Prevention of Cruelty to Children or Animals
As you'll see from the massive non-profit directory on Guidestar.org, there is no shortage of eligible non-profits to choose from. You'll probably want to start your search locally, but as long as the recipient non-profit is willing to accept your donation and they're able to give you all the verifying paperwork to document your donation properly, you should be clear to move forward.
2. Verify and Document the Fair Market Value of Your Real Estate
When you donate any non-cash asset to an eligible non-profit, you need to come up with some sort of substantiation for what the item(s) is/are worth. Take this excerpt from Charity Navigator,
When you give used clothes or other items to charity, the Internal Revenue Service will allow you to deduct the fair market value of the items on your income tax return. The IRS isn't in the appraisal business, so it can't tell you exactly how much each item you donate is worth.
When it comes to valuing real estate, it's going to depend on how much you claim the property is worth.
If you're claiming a tax deduction of $5,000 or greater, this value needs to be substantiated by a professional appraisal. Simply contact a local appraiser and order an appraisal report. This report will outline and explain their professional opinion of the property's market value. When it comes time to file your tax return, this report should be attached to your tax documentation to support your claim of what your tax write off should be for your real estate donation.
Note: In my conversations with three local appraisers in my area (both commercial and residential), the cost of most residential appraisals will be somewhere in the neighborhood of $500 and the cost of most commercial appraisals will start at $1,500 and go up from there (depending on the complexity of their report). Given this – you'll want to factor this additional cost into the overall equation if you're hoping to get credit for a donation of $5,000 or higher (i.e. – sometimes you'll be able to justify the extra cost, sometimes you won't).
On the flip side, if you're claiming a tax deduction of less than $5,000, you can be less “scientific” in nature, and use the same valuation method as your local assessor. As I mentioned earlier – in my home state, property assessors give each parcel an “SEV” (State Equalized Value) of 50% of the property's market value (and from what I've gathered, this number is derived from whatever their gut feeling was at the time). Nevertheless, if you're claiming a value that is LESS than $5,000, you won't need to go much further than this. As long as you have something beyond your own personal opinion to back up your assumption, it should work. Another slightly less-concrete (but potentially useful) way to verify this method would be to simply attach some recent comparable sales from sites like Zillow or Redfin.
3. Retain copies of the closing documentation as evidence of your donation.
In most cases, the documentation doesn't need to be complicated. A simple copy of the Purchase Agreement (confirming that both parties agreed to donate/receive the property for no monetary value), a copy of the Deed (again, listing a transfer value of $0.00) and if it's available, a copy of the Closing Statement (verifying that no funds were received for the transfer of the property).
You could go one step further and fill out a form like this or this (just to be abundantly clear about what's going on), but from my conversations with the CPAs in my area, none of them indicated that this was a necessity.
When Should You Donate Real Estate?
It should go without saying that donating real estate isn't always going to be the answer to your problems. However, it CAN be very beneficial if the numbers make sense.
In order to make the right decision for your situation, you'll have to weigh a few things regarding the deal itself:
- What is your total investment in the property?
- What is the high-end value of this property
- i.e. – What does the county assessor think this property is worth?
- What is the low-end value of this property
- i.e. – What kind of low-ball offers are you likely to get when selling?
If the deal seems to make sense on its own merit, you'll also want to look at the bigger picture of your current financial situation:
- How much money are you on track to make in the current fiscal year?
- How much will you have to pay in taxes for the current fiscal year?
- What other tax write-offs do you already have working in your favor for the current fiscal year?
- How much cash/liquidity do you currently have available
- i.e. – Are you in desperate need of cash right now, or are you in a good position as-is?
The right answer depends on a number of variables.
If you've got a deal with a healthy profit margin (simply looking at the amount you paid vs. the documented appraised value) AND you're facing a tax liability that is larger than the deduction you'd get from donating the property… then YES, it probably makes sense to donate it!
If you've got a deal with a weak or questionable profit margin (amount paid vs. value) OR your tax liability is already going to be less than the credit you'd get from donating the property, then NO, it probably doesn't make sense to donate it.
The point to remember is – the decision to donate your real estate shouldn't be driven solely by your inability to get a property sold. I understand it can be frustrating when a property sits on the market for months on end, but if the math still doesn't come out with a better result in the donation scenario, then don't sell yourself short!
As a general rule, I wouldn't recommend buying any property solely with the intent of donating it. Instead, I would look at real estate donations as a “Plan B” that in some situations, may have the potential to turn out even better than your “Plan A” (but even so… don't pursue anything with the intent of going after Plan B first).
A tax deduction is only useful to the extent that you have a large enough tax obligation to deduct it from… so it should go without saying, this is only a strategy to pursue when your cash position is already healthy enough and when you have a large enough tax burden to hedge it against.
As I mentioned earlier, I'm not a CPA or tax professional, so before you follow through with this action plan – be sure to get educated about the specifics of how this process works in your area, because these details can change based on a variety of factors, like:
- The type of property you're donating.
- Which non-profit you're donating it to.
- What tax bracket you fall into.
- The type of documentation you're able to provide.
As Amanda mentioned in the comments section below,
“There are some very specific rules when writing off donations regarding whether you can take fair market value -OR- your actual basis in the donated property, and sometimes the difference is dependent on what type of entity you’re donating to. There may be times, though, when even your basis in the property is worth the write-off. Especially if it’ll *just* squeak you into a lower tax bracket.”
If you're interested in learning more, check out Publication 526 from the IRS website (note: this publication gets updated every year – so be sure you're working with current information) and once you've got a handle on what you're doing, be sure to call your tax professional.