What Makes a Donation Legally Restricted? 2026

A donation becomes legally restricted when the donor specifies a particular purpose or time period for the use of their gift, and the nonprofit organization accepts that gift with those conditions in place. The restriction is documented in what the law calls a gift instrument—a written agreement, letter, or even the memo line of a check that establishes the donor’s intent. Once both parties agree, the restriction becomes legally binding on the organization.

If you work at a nonprofit, serve on a board, or make major gifts to charities, understanding what makes a donation legally restricted is not optional. Misusing restricted funds can trigger IRS penalties, donor lawsuits, and in extreme cases, the loss of tax-exempt status. The good news is that the rules are clear once you know where to look.

In this guide, our team breaks down the legal framework, the types of restrictions you’ll encounter, the role of UPMIFA, and practical steps your organization can take to stay compliant. We have drawn on IRS guidance, state charity laws, and real-world questions from nonprofit professionals to build a resource that answers the most common—and most critical—questions.

Whether you’re setting up your chart of accounts for the first time or reviewing an existing restricted gift agreement, the information below will help you make confident, legally sound decisions.

What Makes a Donation Legally Restricted?

The single most important factor is this: a restriction only becomes legally binding when both the donor and the receiving organization agree to it. The donor proposes the limitation, and the nonprofit accepts the gift with full knowledge of those conditions. Without that mutual agreement, there is no enforceable restriction.

Only donor-imposed limitations create legally restricted donations. If a nonprofit’s board decides internally to set aside money for a specific program, that’s a board-designated fund—not a legally restricted one. The distinction matters because board designations can be changed at any time by the board, while true donor restrictions cannot.

The legal weight comes from the principle that a nonprofit accepts a restricted gift as a form of trust. The organization is holding and using that money on behalf of the donor’s stated intent. This is why courts and the IRS treat misuse of restricted funds so seriously.

To summarize the core test: Was there a clear donor-imposed restriction? Did the organization accept the gift with knowledge of that restriction? Is there documentation (a gift instrument) reflecting the agreement? If the answer to all three is yes, the donation is legally restricted.

One related question we see frequently on nonprofit forums is what makes a restricted fund legally binding for a church? The answer is the same. Churches are not exempt from these rules—a designated gift to a church building fund, for example, is legally restricted once the church accepts it with that understanding. The faith-based nature of the organization does not change the legal framework.

The Role of the Gift Instrument in Restricted Giving

The gift instrument is the heart of any legally restricted donation. It is the document—or set of communications—that establishes the donor’s intent and the terms of the restriction. Without it, proving that a restriction existed becomes extremely difficult.

A gift instrument can take many forms. For major gifts, it is typically a formal written agreement signed by both parties. For smaller donations, it might be a letter from the donor, an email exchange, the memo line on a check, or even language on a crowd-funding campaign page. What matters is that the donor’s intent is clearly expressed and that the organization accepted it.

The best gift instruments spell out several key elements: the purpose of the gift, any time conditions, how the funds may be invested (for endowments), reporting expectations, and what happens if the original purpose becomes impossible to fulfill. The more detail included up front, the fewer problems arise later.

Our team strongly recommends that every nonprofit adopt a gift acceptance policy that requires a written gift instrument for any donation above a certain threshold—typically $5,000 or $10,000. This protects both the donor’s intent and the organization from future disputes.

A common pain point nonprofit professionals describe is the difficulty of explaining to donors why a formal agreement matters. The simplest framing is that the gift instrument is what makes the restriction real. Without it, the organization cannot guarantee the funds will be used as intended, and the donor has no legal recourse if they are not.

Types of Donor-Imposed Restrictions

Donor-imposed restrictions generally fall into two categories: purpose restrictions and time restrictions. Many gifts combine both, and understanding the difference is essential for proper accounting and compliance.

A purpose restriction limits how the funds can be spent. For example, a donor might give $50,000 to fund a scholarship program, purchase new playground equipment, or support a specific research initiative. The organization may only spend the money on that designated purpose. Using those funds for general overhead or a different program would violate the restriction.

A time restriction limits when the funds can be used. A donor might stipulate that a gift cannot be spent until a future date, or that it must be used over a multi-year period. A common example is a pledge paid in installments over several years—the donor’s payments are restricted until the time conditions are met.

Endowments represent a special category. A true endowment is a gift where the donor requires the principal to be held in perpetuity (or for a specified term), with only the investment income available for spending. These are permanently restricted funds, governed by both the gift instrument and state law under UPMIFA.

Some restrictions combine purpose and time. A donor might give money to be used for a building project (purpose) but not until the organization has raised matching funds (time/condition). These multi-layered restrictions require careful tracking.

Here is a quick comparison of the three fund classifications nonprofits work with:

• Unrestricted funds: No donor-imposed limits. The organization may use them for any purpose within its mission.

• Temporarily restricted funds: Restricted by purpose or time, but the restriction will be satisfied through use or passage of time.

• Permanently restricted funds: Restrictions that never expire, such as endowment principal that must be held in perpetuity.

Temporarily Restricted vs. Permanently Restricted Funds

The distinction between temporarily and permanently restricted funds is one of the most common sources of confusion we hear about from nonprofit accounting staff. Getting this right matters for both legal compliance and accurate financial reporting under GAAP.

Temporarily restricted funds are restricted by either purpose or time, but the restriction will eventually be satisfied. Once the organization spends the money on the designated purpose, or the time period passes, the funds are “released” from restriction and become unrestricted. For example, a $25,000 gift designated for a 2025 youth program becomes unrestricted once it is spent on that program.

Permanently restricted funds never get released through use. The classic example is an endowment, where the donor requires the principal to be preserved forever. Only the investment income can be spent, and even that may carry additional purpose restrictions.

On financial statements, these categories appear as net asset classes. Under the updated nonprofit reporting standards (ASU 2016-14), organizations report two classes: net assets with donor restrictions (combining both temporary and permanent) and net assets without donor restrictions. This simplified reporting replaced the old three-class system, but the underlying legal distinctions remain.

For fund accounting purposes, organizations still need to track temporarily and permanently restricted amounts separately internally. This internal tracking supports compliance, donor reporting, and board oversight.

How UPMIFA Shapes Restricted Donations

UPMIFA—the Uniform Prudent Management of Institutional Funds Act—is the state law that governs how nonprofits manage and invest restricted funds, particularly endowments. As of 2026, every state except the original UPMIFA holdouts has adopted some version of it. If your organization holds endowments or permanently restricted funds, UPMIFA applies.

UPMIFA replaced the older Uniform Management of Institutional Funds Act (UMIFA) and introduced several important changes. Most notably, it eliminated the historical dollar-value concept that required organizations to maintain the original gift value of an endowment before spending any income. Under UPMIFA, the entire fund can appreciate or depreciate, and spending decisions are governed by prudence rules rather than dollar floors.

The law requires organizations to act prudently in managing restricted funds. This includes considering the fund’s total return, general economic conditions, the organization’s other resources, inflation, and the investment policy. The goal is to balance the interests of current and future beneficiaries.

UPMIFA also gives nonprofits the ability to appropriate a portion of endowment funds for expenditure. Each state sets its own cap—commonly 7% of the fund’s value, calculated over a rolling period—on how much can be spent each year without additional donor approval.

For organizations considering modifying an endowment’s purpose, UPMIFA provides a pathway. If the original purpose becomes unlawful, impracticable, or wasteful, the organization may release or modify the restriction through a process that can involve donor notification or, in some cases, court approval.

Legal Consequences of Misusing Restricted Funds

The risks of mishandling restricted donations are real and significant. Nonprofit professionals we’ve heard from describe genuine anxiety about spending restricted money on the wrong thing—and that fear is well-founded.

At the federal level, the IRS takes misuse of restricted funds seriously. An organization that diverts charitable assets away from their intended purpose can face intermediate sanctions excise taxes on responsible individuals, and in extreme cases, revocation of tax-exempt status. The IRS views honoring donor restrictions as part of the organization’s obligation to operate exclusively for charitable purposes.

Donors also have legal recourse. In many states, a donor (or the state attorney general on behalf of donors) can bring a lawsuit to enforce the terms of a restricted gift. These claims are often framed as breach of fiduciary duty or cy pres actions seeking to redirect the funds to a comparable charitable purpose.

Reputational damage can be even more costly than legal penalties. News that a nonprofit diverted restricted funds spreads quickly and can undermine donor trust for years. For organizations that depend on major gifts, that trust is the foundation of their fundraising ability.

The most common misuse scenario involves using restricted funds for overhead or administrative expenses when the restriction specified a particular program. Even well-meaning cash flow management—temporarily borrowing from a restricted fund to cover payroll, for example—can create legal exposure if it is not properly documented and repaid.

State attorneys general are the primary regulators of charitable trusts and restricted gifts. They have broad authority to investigate misuse, order restitution, and in serious cases, remove board members or appoint receivers. Some states, like California and New York, maintain active charities bureaus that pursue these cases aggressively.

How to Release or Modify Restrictions

Sometimes restrictions become impossible or impractical to fulfill. Perhaps a program no longer exists, a building project was completed under budget, or the donor’s original purpose no longer makes sense. The law provides several pathways for releasing or modifying restrictions—but each has specific requirements.

Donor consent is the simplest path. If the original donor (or their designated representative) agrees in writing to release or modify the restriction, the organization can proceed. This works well when the donor is alive and accessible. For gifts from deceased donors, this option may not be available.

UPMIFA modification allows an institution to modify a restriction on a fund if the original purpose becomes unlawful, impracticable, impossible to achieve, or wasteful. For smaller funds (typically under a state-specified threshold, often $25,000 to $50,000), the organization can make the modification internally by notifying the attorney general. For larger funds, court approval may be required.

The cy pres doctrine (from the French “cy pres comme possible,” meaning “as near as possible”) is a judicial doctrine that allows a court to redirect charitable funds when the original purpose cannot be carried out. The court will attempt to find the closest alternative use consistent with the donor’s general charitable intent. This is the primary mechanism for modifying older endowments where the donor is deceased.

Here is a practical sequence for releasing or modifying a restriction:

Step 1: Document why the restriction can no longer be fulfilled. Gather evidence that the purpose is impossible, impracticable, or wasteful.

Step 2: Contact the donor (if living) and request written consent to modify or release the restriction.

Step 3: If the donor cannot be reached, determine whether UPMIFA allows internal modification based on your state’s threshold for fund size.

Step 4: For larger funds or contested situations, file a cy pres petition with the appropriate court, typically through your state’s attorney general’s office.

Step 5: Update your accounting records to reflect the reclassified funds, and document the entire process in your board minutes.

Best Practices for Managing Restricted Donations

Preventing compliance problems starts long before a gift is received. Organizations that follow a structured approach to accepting and managing restricted donations dramatically reduce their legal risk. Based on our research and the experiences shared by nonprofit professionals, here are the practices that matter most.

Adopt a written gift acceptance policy. This document should define what types of restricted gifts your organization will accept, who has authority to approve them, what documentation is required, and how unusual gifts (real estate, securities, complex trusts) are handled. A good policy prevents well-meaning staff from accepting gifts the organization cannot manage properly.

Require a gift instrument for every significant restricted donation. The agreement should specify the purpose, time conditions, investment expectations, reporting requirements, and provisions for what happens if the purpose becomes impossible. Review the document with legal counsel for major gifts.

Set up proper fund accounting. Track restricted and unrestricted funds separately in your accounting system. Assign each restricted gift to a specific fund or project code so spending can be monitored against the restriction. Reconcile these accounts regularly.

Train staff and board members. Everyone involved in fundraising, finance, and governance should understand the difference between restricted and unrestricted funds, why board designations are not the same as donor restrictions, and what the consequences of misuse are. This is one of the most common training gaps we identified in forum discussions.

Communicate clearly with donors. Help donors understand what types of restrictions your organization can realistically honor. If a donor wants to restrict a gift in a way that creates administrative burden or legal risk, have a conversation about alternatives before accepting the gift.

Monitor spending against restrictions. Review restricted fund balances regularly to confirm that spending aligns with donor intent. If a program is winding down or a project is complete, address remaining restricted balances promptly through donor consent or the modification processes described above.

Work with qualified professionals. For complex gifts—endowments, split-interest trusts, gifts with unusual conditions—engage legal counsel and a CPA with nonprofit experience. The cost of professional advice is far lower than the cost of a compliance failure.

Checklist for accepting a restricted gift:

• Does the gift align with your organization’s mission and capacity?

• Is the restriction clearly documented in a gift instrument?

• Do you have the systems to track and report on the restricted funds?

• Has the gift been reviewed by legal counsel if it involves unusual terms?

• Has the board or gift acceptance committee approved acceptance?

• Are the accounting and development teams aligned on how to classify and track the gift?

Frequently Asked Questions

Final Thoughts on Legally Restricted Donations

Understanding what makes a donation legally restricted comes down to three elements: a clear donor-imposed limitation, organizational acceptance, and documented agreement in a gift instrument. When all three are present, the restriction carries the full weight of the law—and that weight exists for good reason. It protects donor intent and preserves public trust in charitable organizations.

If your organization handles restricted gifts, start by reviewing your gift acceptance policy and fund accounting practices. Make sure staff and board members understand the distinction between donor restrictions and internal designations. And when restrictions become impossible to fulfill, use the legal pathways—donor consent, UPMIFA modification, or cy pres—to address them properly. The steps you take today to manage restricted donations responsibly will protect your organization for years to come.