Craig Mason for AL.com writes: A bargain sale is a unique planning opportunity for
the owner of real property to receive cash and obtain a charitable
contribution, while reducing the tax burden and performing a public
service. This charitable planning technique is often overlooked and
definitely underused, and has many applications.
What is a bargain sale? A
bargain sale is a sale of property to charity/government at less than
its fair market value, with a result that is in part a sale of the
property and in part a charitable contribution. In short, there are
several types of bargain sales, the most common of which is when a donor
makes an actual sale of property to charity/government in exchange for
cash or an installment note. Bargain sales can also arise when a
donor/seller transfers property in exchange for like-kind property of
lesser value, or when a donor/seller transfers property subject to
indebtedness.
The
gift portion of a bargain sale qualifies for the income tax charitable
deduction. The deduction equals the difference between the fair market
value and the reduced price. The income tax charitable deduction may be
taken in the year of the gift, even if the donor receives installment
payments for the sale portion. To determine if there is a taxable gain
on the sale, the donor's cost basis is allocated for tax purposes
between the sale portion and the gift portion of the transaction. The
income tax on the sale portion can be spread by receiving payment in
installments on the sale of property.
For example:
Bob
sells to the local municipality a piece of real estate for $400,000,
which is his tax basis in the property. The property’s current fair
market value is $600,000. Bob will have made a charitable donation of
$200,000 and will recognize gain on the sale of $133,333 as follows:
Tax basis of property $400,000
Basis allocable to sale portion $266,667
(400,000 x 400,000/600,000)
Taxable Gain
Sale Proceeds $400,000
Adjusted Basis (266,667)
Taxable Gain $133,333
Charitable Deduction $200,000
Tax Savings (assume 40% tax bracket) $80,000
After Tax Cash from sale and Tax Savings
Sale Proceeds $400,000
Tax (assume 25% capital gain
rate federal and state) on gain (33,333)
Net Proceeds $366,667
Tax Savings from
Charitable Contribution 80,000
After Tax Cash Result $446,667
The
motivating reason behind a bargain sale is not the maximization of
cash. Rarely will the cash and tax savings of a bargain sale equal the
full cash received from the sale of property. Therefore, let’s compare
the outright sale of the property to the example above.
Sales Price (FMV) $600,000
Basis (400,000)
Gain $200,000
Tax on sale (assume 25% capital gain
rate federal and state) 50,000
Cash Received $600,000
Tax (50,000)
Net After Tax Cash $550,000
The
outright sale of the property will net the property owner an additional
$103,333 ($550,000 less $466,667). So why would a person want to enter
into a bargain sale?
That
is a question that has to be answered by the seller. A bargain sale is a
method that is used by many charitable organizations such as The Nature
Conservancy and the Trust for Public Land. A bargain sale allows these
agencies to stretch their fundraising dollars while at the same time
putting significant cash in the hands of the seller. In addition, state
and local governments are using this idea to obtain property for any of
number of uses.
Another
way to utilize the benefits of a bargain sale is through a like kind
exchange. Suppose that an individual owns 400 acres worth $1,000,000
and a tax basis of $600,000. The owner would like to exchange this
property with a charity/government entity for property with a fair
market value of $700,000. Since the person is giving up property worth
more than the property they are receiving, they will be deemed to make a
charitable contribution for the difference. In this case the charitable
contribution will be $300,000 ($1,000,000 less property worth
$700,000).
As a
result of the above exchange, the taxpayer’s basis in the new property
will be adjusted as part of the bargain sale. The taxpayer will take
basis in the new property equal $420,000 ($600,000 x 700,000/1,000,000).
This type of transaction allows the seller to obtain the property that
suits their needs while also obtaining a charitable contribution.
Are
bargain sales limited to land? No, a bargain sale may apply in many
forms including art work, water rights, land and buildings, etc.
Finally,
as with any transaction, sound accounting and tax law advice is needed
to analyze the interplay among the tax benefits and a property owner's
financial situation. Furthermore, you must ensure that all rules are met
to obtain the charitable deduction. Failure to do so can put you in the
same position as a recent Tax Court case (Boone Operations Co, LLC v.
Commissioner, T.C Memo 2013-101) in which the taxpayer made a donation
to the city. The taxpayer was denied a charitable contribution deduction
because the taxpayer failed to obtain contemporary written
acknowledgement of the purported contribution and did not indicate how
much and in what form it received any consideration from the city.
Craig J. Mason is a Partner with Sellers Richardson Holman & West LLP.
Craig has more than 22 years of experience providing tax services to
clients across multiple industries. He holds a B.S. and Masters of Tax
Accounting from the University of Alabama. He began his career with the
KPMG in San Antonio, Texas, later joining the Tulsa, Oklahoma office of
Deloitte & Touche. In 1997, Craig returned to Birmingham where he
worked for Ernst & Young, joining SRHW in 2001. Currently, Craig is a
member of NAIOP, serves as a senior member on the ACRE Leadership Council, represents the firm on the ACRE Corporate Cabinet, and
is a member of the Culverhouse School of Accountancy Professional
Advisory Board for The University of Alabama. Craig is also the Board
Treasurer for Leukemia Lymphoma Society Alabama/Gulf Coast Chapter.
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