Alternative Endings: Early Terminations of Split-Interest Gifts

Split-interest gifts are legal arrangements through which individuals contribute something of value to a nonprofit organization (frequently cash, marketable securities, or real estate), and receive, in return, both a charitable income tax deduction and a benefit of some monetary value. The majority of split-interest gifts are so-called “life income gifts,” whereby the donors receive certain amounts of income for the rest of their lives. The most popular examples are charitable gift annuities and charitable remainder trusts. Participations in pooled income funds have fallen out of favor in recent years.

Another popular split-interest gift – one that is NOT a life income gift – is the retained life estate. With this gift vehicle, the donor contributes real estate – typically, a residence – and receives two things in return. First, an income tax deduction, and second, the right to live in the property for the rest of his or her life. While the life estate does not represent income, it has a value that can be computed. The value of the life estate, for the most part, is based on the age of the donor and the current value of the property.

In these gift examples, the donors are making charitable gifts as portions of their split-interest gifts, and these transactions are irrevocable. The donors cannot undo the gifts – they cannot take the cash or securities or real estate back, even if they change their minds later. But are the donors of these gift vehicles locked into the legal arrangements for the rest of their lives? Is there no way to “get out” of these binding contracts and agreements?

Actually, there ARE ways to get out of these gift arrangements. Here is where we need to review the difference between an agreement that is irrevocable and an agreement that is structured with a limited amount of flexibility. Just because the donors cannot revoke these gifts does not mean they cannot terminate the arrangements. Each of these examples involves some sort of agreement between the donor and the charity in which both parties voluntarily agree to enter into the gift arrangement.

It only stands to reason that if the two parties can agree to enter into the arrangement, they can also agree to exit out of the arrangement, i.e., they can agree to terminate the arrangement. The two parties can agree on one of two different actions to terminate the arrangement: 1) the donor relinquishes all income or other benefits from the arrangement in exchange for an additional income tax deduction or 2) the donor agrees to relinquish all income or other benefits in exchange for a one-time payment, often referred to as “cashing out.”

Charitable gift annuities (CGAs) are by far the most common type of life-income gifts, and by extension, they are the most popular gift vehicle for voluntary terminations. Because CGAs are governed by a fairly simple contract between the donor and the charity, the termination process is relatively straightforward. The sponsoring charity typically asks the donor to put in writing that he or she is irrevocably relinquishing the stream of lifetime payments. The charity should seek guidance to provide the donor with specific verbiage to confirm that the transaction is legally binding.

The charitable remainder trusts – both the annuity trust and the unitrust – are governed by the original trust document. The trust document is typically prepared by the donor’s attorney. The donor should hire the original attorney, if possible, or at least an experienced trust attorney, to work with the trust documents for charitable remainder trusts.

With the retained life estate, the donor may decide on their own that they no longer wish to live in the residence. This is not unusual with older donors who retained the life estate in the property because of decades of happy family memories. After a few years, the donors realize the house does not hold the same sentimental significance. The donor may decide to move out of the house while they still can, to join a retirement community.

In other cases, the decision to vacate the home comes about when the elderly donor has no choice but to move out for health or safety reasons. Either way, the process of giving up the life estate is likely a bit more complicated than relinquishing a gift annuity or even a charitable remainder trust. The donor will need to work with legal counsel to determine the appropriate course of action.

As we mentioned earlier, these donors may choose to give up the benefits they are receiving from these split-interest gifts in exchange for an additional income tax deduction. The other option is for the charity to compensate the donors for the values of their life income interests or life estates.

These possible solutions offer donors and charities a way to terminate split interest gift arrangements in a way that is amicable and beneficial to both parties. The donors are not locked into receiving annuity payments for life, and they are not obligated to occupy the dwellings until they die. The charities may end up receiving greater benefits through the thoughtful and careful navigation of these possible alternative outcomes.

We will have a robust discussion of these opportunities, going through the details in our webinar on November 20 entitled “Alternative Endings: Early Terminations of Split-Interest Gifts.” You may register for the webinar or purchase the recording.