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Saturday April 25, 2015

Article of the Month

Contributions of Mobile Homes and Fixtures

Introduction


Gifts of tangible property typically fall into one of two categories: real property and tangible personal property (TPP). In most cases, the determination as to whether a gift of property is real property or tangible personal property is straightforward. However, in some circumstances, it can be more difficult to determine the correct classification. For example, tangible personal property that has been "affixed" to real property causes the TPP to be treated as part of the real estate for purposes of state real property law, including title, liens and transferability as well as for federal tax law purposes involving charitable gifts.

This article will discuss the differences between TPP and real property and how the classification will affect charitable tax treatment for charitable gifts, how TPP can be converted to real property under state law, as well as planned giving strategies that could be used to structure gifts of property where TPP has been affixed to the land.

Understanding Tangible Personal Property and Real Property


Before determining whether property is tangible personal property or real property, it is useful to define real property and tangible personal property for IRS purposes. IRS Publication 526 provides two helpful definitions of real property and tangible personal property, respectively. Real property is defined as “land and generally anything built on, growing on, or attached to land.” Conversely, tangible personal property is defined as “any property, other than land or buildings, that can be seen or touched. It includes furniture, books, jewelry, paintings, and cars.”

Because real property is defined as “land and generally anything built on, growing on, or attached to land,” the question arises as to whether tangible personal property may be attached to land such that it would be considered real property. According to the Tax Court and a later IRS Revenue Ruling incorporating the Tax Court’s decision, the answer is “yes.”

In Whiteco Industries, Inc. v. Commissioner, (65 T.C. 664 (1975)), the Tax Court held that an outdoor advertising display was tangible personal property for purposes of the investment tax credit. The court set forth six factors to be used in determining whether property is to be considered tangible personal property:

(1) Is the property capable of being moved and has it in fact been moved?
(2) Is the property designed or constructed to remain permanently in place?
(3) Are there circumstances which tend to show the expected or intended length of affixation; that is, are there circumstances that show that the property may or will have to be moved?
(4) How substantial a job is removal of the property and how time-consuming is it?
(5) How much damage will the property sustain upon its removal?
(6) What is the manner of affixation of the property to the land?

In Rev. Ruling 80-151, 1980-1 C.B. 7, the IRS officially incorporated these factors in determining whether property is tangible personal property. Based on the six factors, tangible personal property properly affixed can be considered real property.

Classification Can Affect Charitable Tax Treatment


Determining the correct classification, whether the property is still regarded as TPP separate from the real estate or whether the TPP has become part of the real estate, is very important for federal tax purposes.

A donor who makes a charitable gift of real estate that is long-term capital gain property typically takes a charitable deduction at fair market value. This fair market value deduction is subject to a limit of 30% of the donor's contribution base (most often the donor's adjusted gross income (AGI)). Any unused deduction in the year of the gift may be carried forward for an additional five years.

The applicable deduction and deduction limit for gifts of TPP will depend on several factors, including: (1) whether the TPP will be used by the charity in furtherance of its exempt purpose or the gift is for an unrelated use; and (2) whether the fair market value of the TPP is less than or greater than the donor's cost basis. Consider the following illustrations:

Illustration 1 - A donor makes a gift of TPP. The gift is for the charity's related use. The TPP's fair market value is greater than the donor's cost basis and is long-term capital gains property. The donor may take a fair market value deduction (the higher amount), subject to the 30% deduction limit.

Illustration 2 - Same donor, same property (fair market value of TPP is still greater than cost basis). The gift, however, is for an unrelated use. The donor would have to take a cost basis deduction (the lesser amount), subject to the 50% deduction limit.

Illustration 3 - Same donor. The property, however, has a fair market value that is less than the donor's cost basis (a possible scenario for a mobile home that has lost value over time). In this case, regardless of whether the property is for a related or unrelated use, donor would have to take a deduction at fair market value (the lesser amount), subject to the 50% deduction limit.

The above illustrations briefly demonstrate how the deduction rules and deduction limits could affect donors who make gifts of tangible personal property (keep in mind, however, that any unused deduction in the year of the gift may be carried forward for up to an additional five years). It also raises an important issue for donors and their advisors to consider: Are there tax advantages to affixing tangible personal property to real estate prior to making a charitable gift of real estate? The issue could arise in the case of two common categories of tangible personal property, such as: (1) mobile homes, sometimes called "manufactured homes" or "modular homes" and (2) fixtures.

State Law and Mobile Homes: TPP or Real Estate?


Mobile homes present a unique challenge for donors and their advisors, particularly when the donor is considering making a charitable gift of the mobile home and the real estate upon which it is situated.

Typically, mobile homes are considered tangible personal property under state law. In many states, mobile homes are taxed as personal property rather than real property. When purchasing a mobile home, the owner is usually issued a "certificate of title" or the "manufacturer's certificate of origin." These certificates are often registered with the state agency responsible for issuing certificates of title for vehicles, such as the Department of Motor Vehicles (DMV) or Secretary of State. The title for the mobile home is similar to the certificate of title for a car, boat, truck or other vehicle. Title liens for mobile homes are recorded in much the same way as title liens for vehicles. The transfer of legal title to a mobile home is usually accomplished in the same manner as the transfer of the title to a vehicle. The seller signs over the certificate of title to the buyer and the buyer registers the transfer with the state. A new certificate of title will be issued in the buyer's name. In short, state law recognizes the fact that mobile homes, like vehicles, are designed to be easily moved from one location to another. State law, therefore, generally treats mobile homes like vehicles.

In most states, however, it is possible for the owner of a mobile home to permanently affix the mobile home to real estate. When this is done, the mobile home loses its designation under state law as a mobile home and instead is regarded as an improvement on the real estate to which it is attached. In approximately three-quarters of the states, the owner of a mobile home can convert the mobile home so that it will be treated as a permanent improvement, making it part of the underlying real estate. This is usually done by surrendering the certificate of title or the certificate of origin to the state agency responsible for titling vehicles and then recording an affidavit in the county where the property is located, in the office where real property records are maintained, such as the Registrar of Deeds or the Recorder of Deeds office. This affidavit typically states that the certificate of title has been surrendered and the mobile home has been affixed to and is now part of the real estate. Finally, in some states, the owner must take steps to physically attach the mobile home to the real estate to demonstrate "permanence"—such as building a foundation or concrete slab upon which the mobile home rests. Some states require that an individual seeking to affix a mobile home to real estate also own the underlying real estate, while other states require that the mobile home owner at least has control over the use of the underlying land, such as with a long-term land lease.

One reason that a property owner may want to take steps to make the mobile home part of the real estate is to lower the owner's property tax bill. In some jurisdictions, real property is taxed at a lower rate than personal property. In addition, some states allow for a homestead exemption to reduce property taxes where the property is used as the taxpayer's primary residence. Consequently, a mobile home attached to real estate could be subjected to lower taxes than a mobile home treated as TPP. Another reason relates to financing. Typically, interest rates for loans secured by real estate are often much lower than for loans secured by personal property.

Once affixed, ownership of the home will convey with the underlying real estate. Subsequent transfers of the mobile home will occur when the owner of the land sells and delivers a deed conveying title to the real property to the buyer. If a mobile home owner does not affix the home to the real estate, the mobile home will retain its tangible personal property status.

Tax Treatment of Mobile Home as Personal Property vs. Part of the Real Estate


Three brief illustrations demonstrate the difference in tax treatment between the gift of a mobile home treated as tangible personal property and the gift of a mobile home treated as part of the real estate:

Example 1 - Gift of Real Estate & Separate Gift of Personal Property

Gilbert and Shirley, both age 65, own a nice lot next to a mountain lake. They purchased the lot five years ago for $50,000. Gilbert and Shirley also purchased a new mobile home for $200,000 around the same time that they purchased the lot. They use the home as a weekend getaway. The mobile home is still registered with the state DMV and is not affixed to the land. Accordingly, the mobile home is legally regarded as TPP.

Gilbert and Shirley have decided to move across the country so they can be closer to their daughter, son-in-law and grandkids. They plan to sell their current home and take the proceeds to buy a new home. However, they also thought about gifting the mobile home and the lot to charity. Gilbert called the gift planner at the local charity and discussed the potential gift. Dan, the gift planner, had never encountered a gift of a mobile home. He contacted Art, a local attorney who also serves on the charity's board. Art researched the tax issues and together Dan and Art advised Gilbert that the mobile home is tangible personal property. They told Gilbert and Shirley that a charitable gift of the land and the mobile home would therefore consist of two separate gifts.

Gilbert and Shirley had the lot and the mobile home appraised by two different appraisers. The real estate appraiser determined that the lot was now worth $75,000. The mobile home appraiser determined that the mobile home was now worth $125,000 as tangible personal property. This valuation took into account that the buyer of the mobile home would have to move the mobile home. The gift of the real estate would allow Gilbert and Shirley to take a fair market value deduction of $75,000, subject to the 30% deduction limit. The gift of the mobile home is a gift of tangible personal property. This gift would allow Gilbert and Shirley to take a deduction of $125,000, which is the lesser of fair market value and cost basis, and is subject to the 50% deduction limit. As a result, Gilbert and Shirley are allowed a total deduction of $200,000 for their two gifts. This amount is considerably less than their cost basis of $250,000. Gilbert and Shirley's accountant, Samantha, advises them that their income of $100,000 per year in retirement would allow them to take a charitable deduction for the gift of the mobile home and real estate according to the following schedule:

Year 50% Deduction of
(TPP 50% Type)
50% Deduction
Carry Forward
30% Deduction
(Land 30% Type)
30% Deduction
Carry Forward
Year of Gift (2015)$50,000$75,000 $0$75,000
2016 $50,000$25,000 $0$75,000
2017 $25,000 $0$25,000$50,000
2018 $0 $0$30,000$20,000
2019 $0 $0$20,000 $0
Total Deduction$125,000PLUS$75,000

Example 2 - Gift of Real Estate with Mobile Home Affixed

Assume in the previous example that Gilbert and Shirley had taken the necessary steps to affix the mobile home to the lot when the mobile home was delivered. As a result, the mobile home would legally be regarded as part of the real estate instead of tangible personal property. In this case, Gilbert and Shirley's gift of the lot and the mobile home would be treated as a single gift for tax purposes.

They obtain one appraisal as the mobile home is now valued as part of the real estate. The appraiser uses the replacement methodology and determines that the fair market value of the lot plus improvements is greater than valuing the two components separately. The appraiser also reasons that in order to affix the mobile home to the land, Gilbert and Shirley were required to build permanent utility infrastructure for the lot and this also adds to the overall value. Accordingly, the property was appraised for $250,000—with $100,000 allocated to the land and $150,000 allocated to the improvements. Because the value of the land plus improvements is equal to Gilbert and Shirley’s cost basis, they are able to take a cost basis deduction subject to the 50% limit.

Assuming again that their income is $100,000 in the year of the gift and each of the next several years after the gift, Gilbert and Shirley would claim their charitable deduction on the following schedule:

Year 50% Deduction
(Real Estate)
50% Deduction
Carry Forward
Year of Gift (2015)$50,000$200,000
2016 $50,000$150,000
2017 $50,000$100,000
2018 $50,000 $50,000
2019 $50,000 $0
Total Deduction$250,000

The previous example illustrates a key point: affixing a mobile home to real estate can help the donor maximize the value of their gift. In Example 1, Shirley and Gilbert’s deduction was $200,000 because the value of the mobile home declined in value due to its classification as TPP. However, in Example 2, Gilbert and Shirley's deduction was $250,000 because the mobile home affixed to the real estate produced an increase in value sufficient to offset the mobile home’s decline in value.

Example 3 - Gifts of Appreciated Assets

Assume in the previous example, however, that the mobile home had not lost value and the land had more than doubled in value. Accordingly, the land and affixed mobile home have a fair market value of $400,000. In this case, because the property is long-term capital gain property, if Gilbert and Shirley were to make an outright gift of the property, their gift would be subject to the 30% deduction limit. Here is what Gilbert and Shirley's deduction would look like:

Year 30% Deduction
(LTCG - Real Estate)
30% Deduction
Carry Forward
Year of Gift (2015)$30,000$370,000
2016 $30,000$340,000
2017 $30,000$310,000
2018 $30,000$280,000
2019 $30,000$250,000
2020 $30,000$220,000 (unused)
Total Deduction$180,000

In this case, Gilbert and Shirley will not be able to use $220,000 of the deduction that an outright gift of the appreciated property would generate. (And while they could make a cost-basis deduction election that would allow them to use a 50% deduction limit, this would still cause them to lose out on $150,000 in deduction compared to the fair market value of the property.)

Planned Giving Applications to Maximize Donor Benefits


While many donors may be interested in making outright gifts of property, certain planned giving strategies may be extremely helpful when making gifts of a mobile home. Planned giving strategies leverage the existence of the mobile home in ways that an outright gift does not. It also allows for creative ways to maximize overall benefits to donors in cases where they would otherwise run into an unused deduction due to the deduction limits.

One strategy is to use a charitable gift annuity (CGA). This provides the donors with additional retirement security in the form of CGA payments. Another strategy is to create a life estate reserved. With this strategy the donor conveys the remainder interest in a personal residence, consisting of the land and a mobile home affixed to the property, to charity while reserving a life estate. This allows the donor to continue to use the residence for the rest of their lives. Furthermore, the donor retains the ability to make a gift of the life estate to charity at a later time. In effect, this results in two separate gifts that could increase the donor's total allowable deduction but which would stretch that deduction out over a longer period of time.

Example 4 - Using Land with Mobile Home to Fund a Charitable Gift Annuity

Let's return to Gilbert and Shirley. Assume the same facts as in Example 3. The mobile home is part of the real estate and the appraiser determined an overall value of $400,000 for the property. Gilbert and Shirley have AGI of $100,000 per year and would have $220,000 in unused charitable deduction with an outright gift because they would be subject to the 30% deduction limit.

Samantha, Gilbert and Shirley's accountant, talked to Dan, the gift planner. Putting their heads together they came up with a plan that they were excited to share with Gilbert and Shirley. The idea is for Gilbert and Shirley to make a gift of the property in exchange for funding a $300,000 charitable gift annuity. The $100,000 difference between the property value and the amount funding the gift annuity is treated as an outright gift. Gilbert and Shirley would take a deduction of $100,000 for this outright gift, subject to the 30% deduction limit. In addition, they would be allowed an additional deduction of $73,521 for funding a $300,000 CGA. Based on these two separate gifts, Gilbert and Shirley would be allowed a combined deduction of $173,521 ($100,000 for outright gift + $73,521 CGA deduction) which is nearly the same as the $180,000 total deduction they could take for an outright gift of the entire property. Gilbert and Shirley would still take this deduction over 6 years.

However, with this strategy, Gilbert and Shirley would also receive gift annuity payments from the charity. The difference between the property value ($400,000) and the deductions ($173,521) is allocated to the present value of the CGA payments. The CGA will pay Gilbert and Shirley $12,600 per year for the rest of their joint lives; $5,686.38 of that will be tax free each year. With this strategy, the CGA takes what would be an unusable deduction and converts that to a payment stream for additional retirement security. Gilbert and Shirley love this plan and they decide to move forward with the gift.

Example 5 - Life Estate Reserved

Let's assume that instead of funding a CGA, Samantha and Dan gave Gilbert and Shirley a second proposal. This proposal assumes the mobile home is part of the real estate and is appraised at $400,000.

In this case, Samantha and Dan suggest that Gilbert and Shirley create a life estate reserved. They would make a gift of a remainder interest in the property to charity this year but reserve the right to use the property for the rest of their joint lives. Dan ran the calculation and determined that Gilbert and Shirley would be able to take a deduction of $207,492 if they went forward with this plan. Samantha explained that one of the benefits of this plan is that it would allow Gilbert and Shirley to take their grandkids to the lake for the next several years. Gilbert, who loved to fish with his grandson, liked that option. Shirley did too because the lake was so tranquil and relaxing for her.

Dan also explained, as Samantha nodded in agreement, that the life estate provides great flexibility for future plans. Gilbert and Shirley could make an outright gift of the life estate to charity in the future or use the life estate to fund a CGA, creating an income stream, or proceed to a joint sale with the charity to receive a lump sum payment for that portion of the sales proceeds represented by their life estate.

Samantha explained that if they created the life estate this year and, six years later, at age 71, made a gift of their life estate to charity, that Gilbert and Shirley would be able to take a subsequent deduction related to the gift of the life estate to charity. Samantha showed Gilbert the following chart to demonstrate how they could take the deductions related to the two gifts over a period of 12 years:

Year 30% Deduction
(Real Estate)
30% Deduction
Carry Forward
2015 (Gift #1)$30,000$177,492
2016 $30,000$147,492
2017 $30,000$117,492
2018 $30,000 $87,492
2019 $30,000 $57,492
2020 $30,000 $27,492 (unused)
2021 (Gift #2)$30,000$136,658
2022 $30,000$106,658
2023 $30,000 $76,658
2024 $30,000 $46,658
2025 $30,000 $16,658
2026 $16,658 $0
Total Deduction$346,658

Gift #1 is related to the gift that created the life estate. Gift #2 is related to the gift of the life estate to charity.

This strategy gave Gilbert and Shirley the ability to continue to use the lake front property for six years. In addition, they received a greater total deduction—$166,658 more–than they would have received compared to an outright gift. Gilbert and Shirley were impressed with this option as well.

Treatment of Fixtures


In addition to mobile homes, other types of tangible personal property can also be affixed to real estate. These are commonly referred to as fixtures. Common examples of fixtures include lighting fixtures, built-in appliances, back-up generators, solar panels and other mechanical systems.

Support for the position that fixtures can become part of the real estate comes from Treas. Reg. 1.170A-5(a)(3). This regulation uses the specific example of a chandelier. The provision provides that if a fixture, such as a chandelier, is intended to be severed from the real estate at or prior to the time of the charity’s possession of the real estate, then it will be considered TPP. However, if the donor intends the fixture to remain attached to the real estate at or prior to the time the charity possesses the real estate, then it will be considered part of the real estate.

What is a fixture? The most commonly used test to determine whether an item is a fixture comes from the 1853 case of Teaf v. Hewitt. In that case the Supreme Court of Ohio laid out three factors to determine whether an item of tangible personal property has become a fixture. Those factors are: (1) whether the item is attached to the real property; (2) whether the item has been adapted for the use of the real property; and (3) whether the party making the annexation intended the item to be permanently attached to the real property. The most important of those factors is the intent of the party making the annexation. There must be some objective manifestation evidencing the donor’s intent for an item to be permanently attached to real property. Evidence of that intent could come from the difficulty in removing the item from the real estate or how firmly the item is attached.

Example 6 - Illustration of Fixtures

Hank owns a home worth $300,000. Several years ago, Hank decided he wanted to modify the home to reduce his utility bills. Hank installed solar panels, a windmill, a battery system and a back-up generator to meet his power needs and installed a fresh water well, for potable water, and a water reclamation system for his garden. When Hank originally purchased the materials for his energy and water systems, they were considered tangible personal property. Now that they have been attached to the land, and given Hank's intent to permanently make them part of the real estate, those items are now considered part of the real estate. Therefore, if Hank makes a gift of his home, his deduction for the home - and the fixtures - would be a fair market value deduction, subject to the 30% limit. Of course, Hank could use some of the same creative planned giving strategies outlined above to maximize the benefits of a charitable gift.

Conclusion


The ability to convert tangible personal property gifts into real property has certain advantages in the short term. In some cases, the decision to affix a mobile home, for example, may limit the tax benefits for donors who would like to make an outright gift of their home to charity. These limitations, however, can be overcome by using planned giving strategies to maximize the donor’s benefits for making a charitable gift of real estate. Two possible strategies include the charitable gift annuity and the life estate reserved. Other gift options, not discussed in this article, such as a charitable remainder trust or a bequest may also provide excellent tax benefits to donors.

Published April 1, 2015
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