Friday April 19, 2024
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2.2.1 Gift/Sale of Land
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Inclusion Ratio - Applicable Fraction
Gift of Land: For donors who own appreciated property, a combination gift and sale can maximize tax savings.
Divided or Undivided Interests?: A threshold decision for a gift/sale of land is whether to use a divided interest or an undivided interest.
Joint Sale: Most gift/sale transactions involve a gift by deed of a portion of the real property to the charity, followed by a joint sale.
Tax Benefits: Normally, the gift/sale of land involves appreciated property. If the donor were to sell the entire property for cash, he or she would recognize the difference between fair market value and adjusted cost basis as a long-term capital gain.
Zero Tax Sale: If the gift portion is selected appropriately, the double benefit of the gift portion may enable a zero tax sale.
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Gift 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.
There are several important planning factors for a gift/sale of land. First, there may not be a prearranged sale. Ferguson v. Commissioner. The property must be transferred to the charity with no legally binding obligation in existence. While there may be prospective purchasers "waiting in the wings," there can be no signed or oral binding agreement to sell. If there is a binding agreement, the capital gain will not be avoided on the gift portion.
With all real estate, the charity should determine whether there is debt on the property, whether the donor has good title to the property and whether there are environmental considerations. In addition, if the property is depreciable real estate and there has been accelerated depreciation, a portion of the asset would potentially represent ordinary income. This would both reduce the charitable deduction by the ordinary portion and increase the tax payable on the ordinary gain portion. Sec. 170(e)(1).
When the portion of the land is transferred to charity, there will be a proration of basis. In this situation, the transaction is similar to the proration of basis under the bargain sale rules. Reg. 1.1011-2(a). The balance of the basis will reduce the capital gain on the portion of the property sold by the donor.
Divided or Undivided Interests?
A threshold decision for a gift/sale of land is whether to use a divided interest or an undivided interest. In many respects, the divided interest is beneficial. If the property may be easily divisible, without conflict with local zoning ordinances, a divided portion may be deeded outright to a charity. This enables the charity to own all of that parcel of real property and proceed with a sale under its full control.
However, many donors may prefer giving an undivided interest. Zoning restrictions may preclude a division or the desired gift property may not be easily divisible. An undivided interest can be for any fraction of the total value. In addition, if the property is substantial, with the sale of a portion of the property, both the charity and the donor would receive sale proceeds from their respective shares.
Since the goal is to sell the property, a divided interest transfer could leave the charity with property that is salable and the donor with property that does not sell. This would usually be very adverse to the donor's preferences. With undivided interests, if any part of the property sells, both owners will receive their prorated share of the sale. However, with a transfer to charity of an undivided interest smaller than 50%, it is possible that the Service may demand a minority discount on the charitable deduction. Rev. Rul. 87-37. Thus, there could be a reduced income tax saving with a transfer of an undivided interest.
Joint Sale
Most gift/sale transactions involve a gift by deed of a portion of the real property to the charity, followed by a joint sale. For most properties, the best economic result is for one buyer to acquire the entire property from the charity and the donor.
While both the charity and the donor will be required to deed their parcels or undivided interests to the new buyer, one of the two is usually selected to negotiate the terms of the sale. Prior to the gift of land to the charity, it is very desirable for the charity and the donor to discuss who will handle the sale, how the property will be listed or advertised for sale and the probable price and terms.
Tax Benefits
Normally, the gift/sale of land involves appreciated property. If the donor were to sell the entire property for cash, he or she would recognize the difference between fair market value and adjusted cost basis as a long-term capital gain. Of course, if there is recapture of excess depreciation as ordinary income, part of the sale proceeds would be subject to a higher tax rate. Sec. 1245. Sec. 1250.
The gift to the charity will produce an appreciated property type charitable deduction. Sec. 170(b)(1)(C). As noted above, for gifts of undivided interests smaller than 50%, there may be a discount for minority interest on the fair market value of the gifted property.
Fortunately, the gifted property both bypasses the capital gains tax and produces an income tax deduction. The tax savings from the income tax deduction may offset all or part of the donor's gain on the sale.
Zero Tax Sale
If the gift portion is selected appropriately, the double benefit of the gift portion may enable a zero tax sale. Bypass of gain on the gift portion reduces the total capital gains tax. In addition, the charitable income tax deduction reduces the taxable ordinary income of the donor. Tax savings are thus calculated at the donor's top marginal ordinary rate. On the other hand, the gain on the sale is normally long-term capital gain and taxable at a much lower rate.
In most circumstances, gifting approximately one-third of the property will bypass sufficient gain and produce the necessary income tax savings to offset the long-term capital gain tax payable on the sale portion.
Example 2.2.1A
Carol Wilson bought 30 acres of development property 10 years ago for $60,000. It now has a fair market value of $300,000.
Carol is contemplating a sale to a developer who will build single-family homes on the property. She has discussed the potential sale but has not indicated either orally or in writing a willingness to sell to this developer. In discussions with her tax advisor, she says she would like to reduce the potential tax. If she were to sell and recognize the $240,000 gain, there could be a capital gains tax payable of $36,000. She would like to reduce this tax by at least 60%.
With the advice of her CPA, Carol deeded six of the 30 acres to her favorite charity. At $10,000 per acre, she received an appreciated property deduction of $60,000 and avoided the capital gains tax otherwise payable on the gifted property. The charity and Carol then jointly sold the property to a developer for a total of $300,000. On the sale portion of $240,000, the 20% basis results in a gain of 80%, or $192,000.
From her $240,000, she will owe capital gain tax, but the gift of 20% did indeed reduce her capital gains tax.
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Case Studies on Gift/Sale of Land
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.
A Bargain Sale Over Time:
Arthur Bell is a long-time supporter of the local university where he attended more than 25 years ago. He has attributed his success as an entrepreneur to the excellent education he received from the university and has shown his appreciation as one of the school's most consistent and generous philanthropists. He has made it a point to give at least $50,000 to the annual fund each of the past 10 years and has been active in raising funds for the university. He is currently serving as the campaign chair for an extremely successful multi-million dollar campaign to raise funds for a new performing arts center. The campaign began about one and one-half years ago and 90% of the goal has already been attained. Because of Mr. Bell's entrepreneurial expertise and his drive and compassion for the university, the projected five-year campaign is now expected to be completed in about two years.
A Stadium, Charitable Trusts and a Family Legacy:
The Meyers family (three brothers, two sisters) inherited a sports complex from their parents 10 years ago. The sports complex consists primarily of a baseball stadium that seats about 7,500, complete with locker room and gym facilities. Each of the siblings inherited a 20% undivided interest in the complex and they have been successful in attracting various minor league baseball teams to play there during the baseball season. It has actually been quite a nice investment for them, generating substantial lease income during the season. However, each of the family members is now over 60 years old and they would like to consider selling the property.
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Private Letter Rulings
PLR
201342011 Proposed Bequest Constitutes an "Unusual Grant":
Camp was created as a tax-exempt 501(c)(3) organization operating a camp for ill children. Camp is not a private foundation. It is funded by donations, which have been received from individuals, businesses, corporations and other organizations.
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