Bargain sale of real estate - an often overlooked tax planning alternative

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.

Cashed-Out Gold ETF Investors Face Higher Tax Bill: Report / Gold ETFs, the IRS and Tax Day: Not so Alluring

John Spence for ETF Trends writes: Bloomberg is out with a great story and reminder this week about how investors who sold bullion-backed gold ETFs and are sitting on capital gains could be surprised by higher tax rates than equities.

Gold is considered a “collectible” by the IRS, so gains on bullion ETFs held for over a year are taxed at a 28% rate. [Gold ETFs, the IRS and Tax Day: Not so Alluring]
Taxpayers pay a maximum rate of 20% on long-term gains for stock ETFs. The higher tax rate for gold ETFs may catch some investors by surprise since the exchange-listed products are bought and sold like individual stocks.

George Padula at Modera Wealth Management  told Bloomberg that some clients are facing the tax issue because their previous advisors put SPDR Gold Shares (NYSEArca: GLD) in their taxable investment accounts.

Other bullion-backed ETFs include iShares Gold Trust (NYSEArca: IAU) and ETFS Physical Swiss Gold Shares (NYSEArca: SGOL). [Lydon: Gold ETFs Shed 300 Tons of Bullion This Year]

GLD is the largest gold ETF with assets of $44.7 billion. The fund closed Tuesday with about 1,023 metric tons of gold, down from roughly 1,351 tons at the end of 2012.
The gold ETF is off 18% year to date.

“The ideal place to hold something like that is in an individual retirement account or other non-taxable account,” Padula said in the Bloomberg article. “That can save a lot of headaches.”

SPDR Gold Shares

Full disclosure: Tom Lydon’s clients own GLD.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

Gold ETFs, the IRS and Tax Day: Not so Alluring   

Tom Lydon for ETF Trends writes:    Investors that struck gold last year in one of the physically backed exchange traded funds have discovered a capital gains headache at tax time if bullion-backed ETFs are held in a taxable account. Investors considering such a commodity investment at this time may want to read on before doing so.

“We’ve seen a lot of gold ETFs this year, and we’re pulling out the last few hairs we have over them,” said Bill Fleming, a managing director in the personal financial services practice of PricewaterhouseCoopers, in a Reuters report. “A lot of ETFs have quarterly or monthly dispositions to pay for expenses. All of these are small dollar amounts, but you still have to figure out what your cost basis is.” [Commodity ETFs' Tax Considerations]
Gold, silver and other metals are treated as collectibles by the Internal Revenue Service, meaning they are taxed at the special rate of 28% for the long term. Short-term gains are taxed at the same rate as other short-term capital gains.

The taxation for commodities is complex, and the tax hit is higher because the investor is taxed on any gains as well as the physical holding, which is higher. Amy Feldman for Reuters reports that the tax loopholes also applies to ETFs if they invest in physical holdings, such as bullion. [ETFs During the Tax Season: What to Expect]

The largest gold ETF,  SPDR Gold Shares (NYSEArca: GLD), is an example. If an investor made a long-term gain of $10,000 on a basic stock ETF and have no offsetting losses, you would pay $1,500 in federal taxes. The same gain in a gold bullion ETF would be $2,800, Reuters points out. [ETF Tips as the Tax Deadline Looms]
Here are a few of the realities of commodity ETF investing and taxes:

• These ETFs also may need to sell some of their holdings to pay operating expenses. If that happens, even though shareholders receive no distributions, they will still be taxed on any gains realized when that bullion got sold, and it will also be taxed at that special collectibles rate.
• As with any other taxable gain, you will need to determine your cost basis – the starting price in the investment for tax purposes – on each of those sales. For these funds, you will receive 1099 forms that report your sales for tax purposes.
• This year there is an added paperwork headache for the preparer–the new Form 8949, used to report capital gains and losses on your tax return to account for the new cost-basis rules, has no 28 % column. You will still need to report those gains, figuring them on the 28 % worksheet. All capital gains and losses information ultimately goes on Schedule D.

It is important to consult a professional tax preparer to discuss the realities of how physical ETFs can impact a specific tax situation.
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon’s clients own GLD.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

Special analysis: How to tax and deduct bonuses

Business Management Daily writes: The IRS has confirmed that how you withhold income taxes from supplemental pay, such as bonuses—by using a flat withholding method or aggregating the supplemental pay with other wages—is entirely up to you, employees can’t specify a withholding method. The IRS has also concluded that bonuses paid to employees who must be on the payroll on the date of payment are deductible in the year paid, not in the year services are performed.

Income tax withholding

There are three possible income tax withholding methods that apply to supplemental pay, such as bonuses:

1. Mandatory flat rate withholding at 39.6% on supplemental pay exceeding $1 million
2. Optional flat rate withholding at 25% for supplemental pay not exceeding $1 million
3. Aggregating supplemental pay of less than $1 million with regular pay and withholding as if the total were a regular wage payment (also optional).

The IRS concluded in a General Information Letter that for the flat withholding methods, no other tax rates apply, so employees can’t request withholding at a higher or lower rate, or that an additional amount be withheld. However, for the aggregation method, employees can refile their Forms W-4 to claim a greater number of withholding allowances. Catch: The refiled W-4s also apply to future regular wages, unless employees refile again after receiving their supplemental pay, which the IRS said employees were free to do. (INFO 2012-0063)

PAYROLL PRACTICE TIP: The IRS’ analysis that employees can keep refiling their W-4s isn’t new, and it can play havoc with your payroll processing schedule. The IRS also reiterated that you have discretion regarding when to put refiled W-4s into effect. Under long-standing rules, you may put refiled W-4s into effect with the next wage payment or wait until the start of the first pay period ending on or after the 30th day from the date employees refile with you.

Deducting bonuses

When bonuses are deductible for businesses that use an accrual method of accounting can be tricky. Under the accrual method of accounting, you can take a deduction before you actually incur an expense, but only when all the events have occurred that establish the fact of the liability.

In Chief Counsel Advice, the IRS concluded that bonuses were deductible in the year paid because employees were required to be employed on the date bonuses were payable. Bonus money wasn’t reallocated among the remaining employees in the bonus pool if employees terminated before the bonus payment date; instead, the money reverted to the company. IRS: The fact of the liability wasn’t established because there was no fixed liability in the year services were performed. Rather, the liability became fixed only if the contingency was satisfied—that is, when employees were still employed on the payment date. (ILM 201246029)
PAYROLL PRACTICE TIP: One small tweak to this incentive pay plan would have changed the result: If forfeited amounts went back into the bonus pool and were split among the remaining participants, the fact of the liability would be established.

ACA small employer tax credit: Are you eligible?

Ashley Gillihan for HR.BLR.com writes: Small employers and large employers alike are facing changes to their health plans due to the next wave of Affordable Care Act (ACA) regulations going into effect in 2014. But you may not be aware that there is a small employer tax credit available for small employers who choose to offer healthcare benefits to their employees.

What is the small employer tax credit under the ACA?

Small employers are eligible for a health insurance premium tax credit under the ACA. Here are some of the details:

• Small employers are eligible for a tax credit equal to a portion of the employer's cost to provide health insurance. Different sections of the ACA hold differing definitions of "small employer." For the purposes of the tax credit, a small employer is one with less than 25 full-time equivalent employees, and annual average wages from the preceding year of less than $50,000.
• "Whether you're a small employer is determined based on 'controlled group' rules." Ashley Gillihan explained in a recent BLR webinar. The ACA defines what group you are a part of, so some small employers who otherwise meet the definition may still not qualify. Be sure to check the rules to see if you qualify – even if you meet the above requirements.
• Small employers must have contributed at least 50 percent of the cost of the health insurance premiums to qualify for the credit.
• The credit amount is generally 35 percent through 2013. It will be 50 percent thereafter.
• As you get closer to either of those thresholds – number of employees or wages paid – the amount of the credit reduces. The credit amount begins to phase out for employers with more than 10 employees and/or more than $25,000 in average wages.
• The credit is based on the lesser of your actual contributions or the average premiums in the state.
• Until 2014, the credit applies to any accident and health insurance (major medical) coverage provided. Beginning in 2014, the credit will only apply to coverage offered through the exchange.
• The credit is only available for 2 more years beginning in 2014.

If you're a small employer who qualifies, taking the tax credit provided under the ACA could be an incentive for you to offer coverage or at least a way to offset the costs of doing so.
That said, remember that taking the credit means you can't take the tax deduction that is already available. "The issue depends on whether it's better to take the credit versus the deduction that you get under the code for your employer contributions towards accident and health coverage. You've always gotten a deduction for amounts you paid to the carrier. You get the deductions in the year in which you actually pay the carrier. You don't get the deduction if you take the credit. And it depends on your particular circumstances whether the deduction makes more sense than the credit." Gillihan noted.

For more information on the small employer tax credit under the ACA, order the webinar recording of "Small Business and the ACA Explained: Compliance Obligations, Tax Credits, and More." To register for a future webinar, visit http://store.blr.com/events/webinars.
Attorney Ashley Gillihan is counsel in the Atlanta office of Alston & Bird LLP. He focuses his practice exclusively on health and welfare employee benefit compliance and litigation issues for employers, health plan administrators, and other health and welfare benefit plan service providers.

Spring Cleaning Tips to Save Money at Tax Time

Lisa Greene-Lewis for US News World Report writes: Spring is in the air, meaning it’s that time of year when people start fresh. Homeowners go through their home, and get rid of old clothes, furniture and unwanted items. But what if you could declutter your life, help others and save money all at the same time?

Donating money or non-cash items to qualified charitable organizations can help you save on your 2013 tax return by increasing your itemized deductions. As such, taking steps now can lead to a fatter tax refund next year.

But what items should you consider for donation when you start your spring cleaning spree? Let’s take a closer look at the requirements for various items.

• Used clothing. Old clothes are almost always in high demand throughout the country. However, only donate clothing that is in good condition, and use the fair market value when determining the value of non-cash items. Free tools like Turbo Tax ItsDeductible can help you determine the FMV of non-cash donations, and make tracking your donated items easier. The Internal Revenue Service uses the average price buyers pay at thrift or consignment stores as an estimation of an item's FMV.

• Household goods. Charitable organizations are often in need of items such as dishes, cutlery and appliances to help individuals and families settle into a new home. Used cookware and furniture must also be in good condition to be eligible for donation.

• Jewelry and gems. If you plan on donating jewelry or gems to a qualified charity, be sure to obtain a written assessment from a specialized jewelry appraiser. IRS regulations on how jewelry donations are deducted vary depending on how the item is used by the organization.

• Cars and boats. What a charity does with the car or boat you donate can impact the size of the deduction you can claim. If the charity sells a donated car for more than $500, you can deduct the smaller of the proceeds or the vehicle’s FMV on the date of contribution.

• Stocks and bonds. There’s an added bonus in donating these types of financial commodities. If you’ve owned a stock for a significant period of time, its value may have doubled or tripled. When donating appreciated stock to a charity, you may avoid capital gains tax since the FMV of donated stock held over one year is the value on the date you sell it – not the date you purchased it. For those who make sizable donations each year, this is a smart strategy to maximize your charitable giving while minimizing your taxable gains.

Before taking your donations to the charitable organization of your choice, check the IRS list of approved tax-exempt organizations. Also ask for a receipt from the charity, so you’re eligible to deduct the value of the donated goods. Donations worth more than $250 must be accompanied by a written record, while those more than $5,000 require a written appraisal. Helping those in need is a fulfilling deed, and getting more money come tax time in the process makes charitable giving that much sweeter.

IRS Issues New Home-Office Deduction

SZ Berg for MainStreet writes: he Internal Revenue Service has issued a new rule to make it easier for home-based business owners and some home-based workers to save both time and money. For the 2013 tax year, rather than itemize business expenses, qualified taxpayers with home offices can choose to take a deduction of $5 per square foot of home-office space for up to 300 square feet for a maximum of $1,500.
 
There are at least three groups of home business owners who will benefit from the new rule, according to Xavier Epps, a financial advisor and IRS-registered tax return preparer at XNE Financial Advising.

Home-based small business owners who would otherwise skip this deduction because of the length of the tax form and lack of proof for expenses will benefit the most from the flat rate option, says Epps. So, too, will those who hire a tax professional due to the complexity of the tax forms, if they have a relatively simple Schedule C, because they will be able to forgo tax preparation fees, he says.

A third group that could benefit are those qualified taxpayers who take a full deduction of their mortgage interest, real property taxes and homeowners insurance on Schedule A but who would normally be required to reduce their Schedule A deductions by the amount claimed on their business and, in essence, lose out on a portion of the deduction on Schedule A due to the reduction, says Epps. Now they can simply take up to 300 square feet of the home and receive $5 per square foot without reducing the Schedule A itemizations.

However, for many taxpayers, the new "safe harbor" method may cost them more of both time and money, say tax experts, because they will have to calculate the taxes using both methods and compare outcomes. And, there are some caveats.

The IRS says that taxpayers who opt for the easier route can still deduct business expenses that are unrelated to the home office, such as advertising and supplies. These deductions do not have to be allocated between personal and business use, as is required under the regular method. However, they cannot depreciate the portion of their home used for business, although they deduct allowable mortgage interest, real estate taxes and casualty losses on their home on Schedule A.

Further, loss carryovers in a prior year from the use of the regular method cannot be claimed in a year using the simplified method, and "any amount in excess of gross income may not be carried over, unlike the regular method," warns Wendy Valentino, a CPA at Cohen Greve & Company CPA.

But that's not all: "Once you make an election to use this safe harbor method for the home office ... you cannot later go back and amend your tax return for that year," says Gail Rosen, a CPA.