Charities Need a High Level of Expertise to Assess Gifts of Restricted Stocks

Greater sophistication is needed among finance officers, fund raisers, and other non-profit leaders if they are to evaluate whether proposed gifts of restricted stock are worth the trouble, experts say.

Unlike stock in a publicly traded company, which can be sold immediately, unmarketable

securities may not generate a return for years. Among the categories increasingly favored by some donors are stock or stock options in high-technology and other companies that have recently gone public. Under Securities and Exchange Commission regulations, such stock cannot be sold for a certain period.

Other gifts of restricted stock on the rise include real-estate shares, thinly traded securities, and privately held stocks.

Charities must be clear about what the illiquid shares can be used to accomplish, experts say. Some charities, they note, have had problems in trying to use such non-cash gifts to set up “donor-advised funds,” which allow donors to recommend how their gifts are used and which require that a certain percentage of the assets go to charity each year. Some funds ran into problems because their assets were not yet liquid and could not generate the required payout.

Certain types of restricted securities that are attractive to some charities are actively shunned by others.

For example, gifts of shares in real-estate investment trusts, called REITs, have become more common in recent years. Investment regulations require that companies offering such stock have 100 or more shareholders. As a result, many universities, community foundations, and other non-profit organizations have been approached by companies that want them to act as shareholders and hold the REITs; in return, the charity pockets any dividends that they earn.

Fund raisers at institutions like Cornell University accept REITs willingly; simply holding the shares, they say, provides the institution with income from the dividends at little or no risk of any loss. But others, such as Peter J. Ticconi, a senior fund raiser at Johns Hopkins University, have decided against it. The reason: Dividends are often insignificant, and the companies often have shown little charitable intent.

“I’ve talked to a couple of these companies, and I felt that they would be using us,” says Mr. Ticconi. “Where is the individual coming forward who is being philanthropic? It seemed more like a fiscal maneuver to me.”

Another type of gift that is increasingly common but that experts say may not always be a good idea to accept is stock in a privately held family business or limited partnership. With such gifts, a family member typically donates his or her shares in the company to a charity; the charity holds the stock until the company can buy the shares back for cash.

Many financial experts believe that such gifts will multiply as families look for ways to transfer assets to the younger generation. Temporarily giving shares in a family business to charity can provide a donor with potent tax benefits, including a reduction in taxes incurred by passing the business to the donor’s heirs.

That’s why non-profit organizations need to take extra pains to ensure that donors have a sincere desire to make a gift and that accepting shares in a family business will serve the charity’s interests as well as the donor’s, experts say.

There are several instances in which the charity’s interests may not be served. The family business might be unable to come up with the cash to buy back its shares — leaving the charity with a company it needs to get rid of and putting it in an awkward position with the donors. Or unscrupulous family members might seek to buy back the shares for less than they are worth.

The charity could also get in legal hot water if it was asked to be a majority shareholder in the family business, for instance, and the business was subsequently sued.

“Charities need to watch out for stock in a small business that might go down, or where they are telling you that you must offer the shares first to the shareholders for a reduced price,” says Marc Owens, a Washington lawyer who formerly headed the Internal Revenue Service’s tax-exempt division. In the last two years or so, Mr. Owens notes, the I.R.S. has taken steps to crack down on gift transactions that provide more benefits to donors than to charities.

“That’s not to say that many of these assets are not perfectly legitimate,” says Mr. Owens. “But charities need to be careful that they are not taking something that has so many strings attached that it has no value or a reduced value, and their tax exemption is being exploited by an individual.”

Many charities do report favorable results from accepting privately held securities.

George Bittner, vice president for development at the Greater Kansas City Community Foundation, in Missouri, says his charity has successfully negotiated several gifts of stock in family-owned businesses. By careful examination and making sure the businesses are appraised by objective experts, he says, the community foundation has avoided any problems.

One safeguard the foundation has used: getting a second appraisal when a long period has elapsed between the gift of stock and the time at which the family business buys it back. The business pays the price of the second appraisal.

By taking such precautions, Mr. Bittner says, the foundation can offer an attractive method by which families can make gifts that are both personally and charitably advantageous.

Barnett Helzberg, for instance, gave his shares in a privately held family business — a chain of more than 100 jewelry stores headquartered in Kansas City — to the community foundation. Mr. Helzberg transferred the stock gradually — about $100,000 worth of stock annually — to the foundation over a period of several years.

That arrangement not only allowed Mr. Helzberg to take a sizable tax deduction each year, but it also enabled him to avoid paying certain corporate taxes. What’s more, he was able to bypass additional gift taxes he would have paid had he given the shares outright to his heirs.

Mr. Helzberg says that donating the shares and buying them back made it possible for him to make a large gift cost-effectively each year.

That, he says, “put more cash in my jeans, but it also built up my charitable muscle and got me into the habit of giving.”