Friday April 26, 2024
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2.1.1 Bargain Sale to Charity
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Bargain Sale to Charity
Overview: A bargain sale occurs when an individual transfers an asset to charity and receives less than the fair market value in return.
Charitable Deduction - Appreciated Property: In nearly all cases, bargain sales involve the transfer of appreciated property.
Reduction Rules: The charitable deduction may be reduced if the asset consists in part of ordinary income, is tangible personal property not subject to a related use by the charity, is real property subject to ordinary-income recapture or is short-term capital gain property.
Long-Term Capital Gain: The vast majority of bargain sales involve a charity purchasing appreciated property that the donor has held for more than one year.
Donor Motivation for a Bargain Sale: Donors may choose to participate in a bargain sale for several reasons.
Bargain Sale of Real Property: There are three important considerations when a charity is purchasing real property, even though it is paying a bargain price.
Zero Tax Bargain Sale: With a bargain sale, the excess of fair market value over the price paid produces a charitable deduction.
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Overview
A bargain sale occurs when an individual transfers an asset to charity and receives less than the fair market value in return. The fair market value less the value returned is a charitable gift. The donor will benefit from the bypass of gain and receive a charitable deduction on the gift portion, but must recognize taxable gain on the value returned to him or her.
Charitable Deduction - Appreciated Property
In nearly all cases, bargain sales involve the transfer of appreciated property. For example, a donor transfers stock with a fair market value of $10,000 and a basis of $4,000 to charity and receives a payment of $4,000 in cash. Since the fair market value less the price paid is $6,000, the donor receives a charitable deduction of $6,000. Reg. 1.1011-2(c), Example 1. As is true of all appreciated property gifts, the charitable deduction is limited to 30% of the adjusted gross income, with a potential carry forward for five additional years. Sec. 170(b)(1)(C).
The order for deductions will be the current year cash deductions taken first, then current year appreciated deductions taken second. The deductible amount will normally exceed $5,000 and therefore must be based on a qualified appraisal. Reg. 1.170A-13(c). The appraisal may be made up to 60 days prior to the gift and not later than the date the taxpayer's return is due (with extensions). However, since the donor and the charity may negotiate the amount to be paid for the asset, it is almost always beneficial to have a preliminary or full appraisal completed prior to the bargain sale.
Reduction Rules
The charitable deduction may be reduced if the asset consists in part of ordinary income, is tangible personal property not subject to a related use by the charity, is real property subject to ordinary-income recapture or is short-term capital gain property.
Gifts of inventory and other ordinary income property require that the gift portion claimed as a deduction be reduced to cost basis. Sec. 170(e)(1). If the bargain sale involves tangible personal property such as art, vehicles or collectibles, and the charity does not plan to use the asset for a related use, then the deduction is reduced to the lesser of fair market value or cost basis. Reg. 1.170A-4(b)(3)(ii). Real property with accelerated depreciation will include an element of ordinary income for the excess of the accelerated over straight-line depreciation. This excess amount will lead to a reduction of the charitable deduction under ordinary income rules. Finally, short-term capital gain assets are deductible at cost basis. Sec. 170(e)(1)(B).
Long-Term Capital Gain
The vast majority of bargain sales involve a charity purchasing appreciated property that the donor has held for more than one year. If the donor were to sell the asset, then the difference between the fair market value and the adjusted cost basis would be reported as long-term capital gain.
With a bargain sale, the gift is the fair market value less the sale price. With respect to the taxable sale portion, the difference between the sale price and the allocated basis will be in most cases long-term capital gain. Reg. 1.1011-2(a)(1).
If a donor transfers stock valued at $10,000 to a charity for $6,000 and the stock has a cost basis of $2,000, then the donor has made a gift of $4,000 and a sale of $6,000. Since there is 20% basis on all shares of stock, the sale of $6,000 worth of stock would be reduced by an allocated basis of $1,200, leaving a net long-term capital gain of $4,800. Reg. 1.170A-4(c)(1).
Donor Motivation for a Bargain Sale
Donors may choose to participate in a bargain sale for several reasons. First, the transaction is very convenient. Charities are willing to make the transaction flow smoothly. Staff members may help locate independent appraisers and assist the donor with the real estate procedures necessary to transfer the property. Second, it may be possible to reduce real estate transfer costs by saving a real estate agent's fee. If the property has not been previously listed, the charity and the owner may deal directly. Third, the donor receives the benefit of the full fair market value under the independent appraisal. Fourth, the donor may receive a cash payment for the full value of the negotiated bargain sale price. Fifth, the donor may select a convenient date for closing the bargain sale. Sixth, the combination of being able to bypass gain on the gift portion and receive a charitable tax deduction on that gift will reduce, or in some cases offset, the tax payable on the portion sold. When the donor considers the convenience and tax benefits of the transaction, he or she still will receive a good return on the initial investment. Seventh, the donor may feel wonderful for assisting a charity he or she cares about. And finally, they appreciate the recognition they gain for their gift.
Bargain Sale of Real Property
There are three important considerations when a charity is purchasing real property, even though it is paying a bargain price. First, there should be a preliminary check on title to make certain that the donor is the actual owner of the property. Second, the charity should attempt to determine whether there are any debts or back taxes payable on the property. Third, if the property is commercial or industrial in use or there is any reason to be concerned about potential environmental risks, then an environmental impact survey should be completed.
While these items will normally be completed prior to closing, it is desirable to obtain as much information as possible in all three areas prior to negotiations over price. A cloud on title, the existence of debts or back taxes against the property or environmental problems would clearly affect the value and price paid for real property.
Zero Tax Bargain Sale
With a bargain sale, the excess of fair market value over the price paid produces a charitable deduction. Normally, this is an appreciated-type charitable deduction that may be used up to 30% of adjusted gross income. Sec. 170(b)(1)(C). If the asset is a long-term capital gain asset, then the sale price less the prorated basis on that amount will be subject to tax at the reduced capital gain rate.
Capital gains taxes are bypassed on the charitable portion and the income tax deduction on that portion saves tax at the donor's top ordinary income rate, which in some cases is nearly double the capital gains rate. Thus, the donor can significantly reduce the total tax payable. A gift of approximately one-third of the asset and a bargain sale for the remaining two-thirds may result in a complete tax offset. The tax savings from the charitable deduction taken against ordinary income may be equal to the tax payable on the long-term capital gain.
Example 2.1.1A Real Property Bargain Sale
John Donor purchased vacant land for $50,000 several years ago. The land is adjacent to the new community medical center building. Since the medical center would like to acquire the property for future expansion, John has been discussing options with the gift planner from the medical center.
The property is currently valued at $200,000. With a cost basis of $50,000, there is approximately 25% basis and 75% gain in the property. The medical center is willing to pay $120,000 for the property.
Since John and his family members have been patients at the medical center, they would like to enter into a transaction that would benefit the center. He is willing to sell the $200,000 property for $120,000. This entitles John to a charitable deduction of $80,000 for a gift of appreciated property. The basis is prorated and, with a 25% basis, or $30,000 on the sale portion of the $120,000, John must report a long-term capital gain of $90,000.
John will pay a tax on the realized portion of the gain, while avoiding capital gains taxes on the gift portion. John Donor receives the $120,000 cash from the sale, plus an additional net tax savings. Note that the charitable deduction is limited to 30% of AGI, with a five-year carry forward. In some cases, the income tax savings may be spread over one to six years.
Example 2.1.1B Bargain Sale Of Home
Bill and Sue Donor bought a lovely home in a very good neighborhood 20 years ago. They now are retiring and would like to sell their home and move to a new property in a retirement community. The home they bought 20 years ago for $300,000 now has a fair market value of $1.5 million.
They enter into discussions with their favorite charity about the possible purchase of the home. They would like to sell the home, receive sufficient funds to buy a new property and enjoy additional liquidity for their retirement security. Since they have not used their $500,000 exclusion on their home, they are interested in receiving $800,000 or more in cash.
After extensive discussions, the charity indicates that it would be willing to pay $1 million for the home. This would enable Bill and Sue to claim a charitable deduction for the $500,000 excess value. This appreciated-property-type deduction is usable to 30% of adjusted gross income this year, with a carry forward for an additional five years.
Bill and Sue receive $1 million in cash. This equals two-thirds of the total value of the property. With the allocation of two-thirds of the $300,000 basis, or $200,000, plus their $500,000 exclusion for the sale of their principal residence, their adjusted basis is $700,000. They then have a taxable long-term capital gain of $300,000.
However, in their income tax bracket, the potential tax savings over the six years on the $500,000 is substantial. They are therefore able to receive $1 million plus have potential additional net tax savings.
Bill and Sue enjoy the convenience of selecting the time for the sale, working with the charity's cordial staff and benefiting from a sale with substantial cash transfer and no net tax cost. In addition, they feel good about making a major gift to their favorite charity and appreciate the recognition.
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Case Studies on Bargain Sale to Charity
Simon Seys Installment Bargain Sale:
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.
Gift of an Installment Note To Charity:
Ashley White, 77, owned much of the land surrounding a local private university located in a small rural town. Three years ago, the university gained national recognition when a popular magazine named it one of the top 50 schools in the country. As a result, the student body grew quite rapidly as students were drawn to the university and its program. Not surprisingly, the university sought to expand its campus to accommodate this new growth. The university approached Ashley about making a gift of her land to the university, but she was not very receptive to the idea. She did agree to sell her land to the university on a 10-year installment note. The land was valued at $1 million and had a cost basis of $100,000. The university agreed and the transaction was completed.
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Related Topics on Bargain Sale to Charity
2.1.2
Gift of Mortgaged Property:
The majority of real estate is encumbered by debt. When the real estate is transferred, the debt previously recorded with the County Registrar of Deeds remains on the property. If the obligation is solely against the property, the debt is termed "non-recourse." If the obligation is against both the property and the owner personally, the debt is termed "recourse."
2.2.1
Gift/Sale of Land:
For donors who own appreciated property, a combination gift and sale can maximize tax savings. A portion of the land is transferred by deed to a charity. Normally, the charity and the donor then jointly sell their respective portions of the property. The donor bypasses gain on the gift portion and uses the charitable income tax savings from the gift portion to offset, in part or in whole, the tax payable on the real property not donated.
2.2.2
Gift/Sale of Stock:
The gift/sale of stock is logistically quite easy to accomplish. Shares of stock are divisible. Most shares of public stock are now held in street accounts. The desired number of shares may be transferred directly through a financial services firm to the qualified charity.
Cohan:
In Marshall Cohan et ux. et al. v. Commissioner; T.C. Memo. 2012-8; Nos. 19849-05, 19854-05, 19857-05 (9 Jan 2012), the Tax Court denied charitable deductions claimed as a result of a bargain sale.
Esgar Corp:
In Esgar Corp. et al. v. Commissioner; T.C. Memo. 2012-35; Nos. 23676-08, 23688-08, 23689-08 (6 Feb 2012), the Tax Court greatly reduced three claimed conservation easement deductions.
Crimi:
In John Crimi et al. v. Commissioner; T.C. Memo. 2013-51; Nos. 13252-09, 13262-09, 20519-09, 22374-09, 22417-09, 22531-09, (13 Feb 2013), Tax Court Judge Laro determined that a sale below fair market value qualified for a charitable deduction. While the appraisal was not attached to IRS Form 1040, the deduction was permitted under the "reasonable cause" exception of Sec. 170(f)(11).
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