The Net-Proceeds approach to gift annuities funded with real estate is an innovative approach designed to produce the best outcomes for both the donor and the charity. 

Because IRS regulations prohibit a completed sale, or a binding sale agreement, before the gift is made, charities have traditionally been forced to estimate the sale proceeds they will receive from selling the property. This estimated value is then used to determine the gift annuity payment. 

To estimate expected sale proceeds, most charities apply inexact discounts to calculate (1) selling expenses and (2) the price for which the property will sell. If the discounts are too small, or too large, the result is an annuity payment that is larger than it should be or smaller than it should be.

The Net-Proceeds Alternative

Rather than applying inexact discounts, CMC uses the actual net sale proceeds to determine the annuity payment. Perhaps the following Scenario best illustrates CMC’s approach.

Sample Scenario

Mr. Smith, age 74, owns a rental property with an appraised value of $750,000, and a cost basis of $225,000. He transfers the property to the College on March 1, in exchange for an agreement that the College will execute a charitable gift annuity with a gift date of March 1, but with the obligation to make payments beginning on the day the College receives the net cash sale proceeds from escrow.

In early April, the property sells and, on May 15, the College receives $705,000 from escrow. At his age, Mr. Smith is entitled to a gift annuity rate of 6.1%. Based on $705,000 of net cash sale proceeds, the gift annuity will pay him $43,005 annually. 

Because the IRS requires the gift annuity rate to be stated as a percentage of the appraised value, the annuity amount of  $43,005 is divided by the gift value of $750,000 to determine an Interpreted Gift Annuity Rate, which, in this case, is 5.734%. Thus, the gift annuity will be executed with a gift date of March 1, a gift value of $750,000, an annuity rate of  5.734%, and a beginning date for payments of May 15, when the sale proceeds were received.  

Because the annuity was funded with appreciated real estate, $21,434 of the payment will be taxed as capital gain, $9,186 will be tax-free and $12,385 will be taxed as ordinary income for the first 13.2 years, per the IRS. Thereafter the entire 
annuity will be taxed as ordinary income.

Of the $525,000 in total capital gain, Mr. Smith must report only $283,117 of the capital gain. This is reported over 13.2 years, in annual installments of $21,434, as shown 
above. The remaining $241,883 of capital gain is not subject to tax.

Mr. Smith is also entitled to a charitable deduction of $345,547. He may claim this amount up to 30 percent of his adjusted gross income. Unused deductions may be carried forward for up to five additional years.