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Thursday, May 2, 2024
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Case Studies |
Simon Seys Installment Bargain Sale
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Case:
Simon Seys is a longtime supporter of Rydell University, where he attended law school some 20 years ago. He has attributed his success as a famous trial lawyer to the excellent education he received from Rydell University's School of Law. Rydell's School of Law is currently seeking to expand its campus, and, coincidentally, Simon owns investment land right next to the law school. The land would be an ideal fit to fill the University's need for additional land, but, Rydell has limited available funds to purchase the land. Simon purchased the land about eight years ago for $200,000 and it is now worth $800,000.
Simon recently pledged, during Rydell's capital campaign, to give $50,000 a year for the next 10 years. After discussions, Simon agreed to enter into a bargain sale whereby Rydell will purchase the land for $300,000.
Based on the bargain sale rules, Simon will receive a tax deduction of $500,000, the difference between the fair market value of the land and the purchase price. Also, he will be required to report capital gains of $225,000 on the $300,000 he received, based on his allocated cost basis of $75,000. Finally, this gift will satisfy Simon's pledge obligation of $500,000 ($50,000 a year for 10 years). The difficult part for Rydell, however, is coming up with the $300,000 purchase price.
Question:
Can Rydell pay the $300,000 purchase price with a five-year installment note? What potential downsides are there to Rydell in doing so?
Solution:
If Simon is agreeable, there is no prohibition against Rydell's purchasing the land with an installment note. Thus, Rydell would make principal and interest payments on the note to Simon each year. Because the note would be spread over five years, Rydell would be able to meet its financial obligations comfortably.
However, an installment bargain sale could cause the land to be treated as "debt-financed property" in Rydell's hands. Consequently, the land could generate unrelated business taxable income to Rydell, but Rydell may be able to avoid this tax trap if its use of the land is substantially related to its exempt purpose. Rydell can meet this narrow exception, since it intends to use the land to expand its campus and teaching facilities. Hence, Simon and Rydell agree to the installment note and close the gift.
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