Web site:
The Planned Giving Design Center, LLCs group location on the PGDC website.
Phone:
704.698.4050
Links to previous sections of book are found at the end of each section.
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The last section reviewed how the “sale” part of the basis is used to calculate the donor’s capital gain. But, what happens to the “gift” part of the basis? When would a donor use this in a tax calculation? |
| The basis in gifted property is not relevant when the property can be deducted at its fair market value. In such cases, if an item of property were worth $100,000, the charitable deduction for gifting such property would be $100,000 regardless of the basis in the property. However, some types of property gifts to charity may be deducted only at the lower of basis or fair market value. For example, gifts of “unrelated use” tangible personal property are deducted at the lower of basis or fair market value. (“Unrelated use” here means that the charity will not be physically using the tangible personal property item in furtherance of its charitable mission, but most likely will instead be selling the item and using the proceeds.) In the case of a bargain sale involving such property, the deduction would be limited to the “gift” portion of the property’s basis. Similarly, a gift of short-term capital gain property (i.e., appreciated property held for 12 months or less) is also valued at basis and the deduction for a bargain sale of such property is limited to the “gift” portion of the property’s basis. |  |
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Consider the previous example, but now suppose that the gifted property was “unrelated use” tangible personal property. Because gifts of “unrelated use” tangible personal property can be deducted only at the lower of basis or fair market value, the donor in this case may deduct only the basis. However, the donor may not deduct the entire basis, because part of the basis was applied to the “sale” part of the transaction (and used in the donor’s capital gain calculation). Instead, the donor may deduct only the “gift” portion of the basis, which, in this transaction, was $100,000 (i.e., 20% of the original $400,000 basis). |
| As mentioned previously, there are tax benefits to using bargain sales, especially when compared to the alternative transaction of selling an item of property for its fair market value and then donating a portion of the proceeds to charity. |  |
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The primary benefit of a bargain sale transaction as compared with selling the property at fair market value and then making a gift to charity out of the proceeds is the partial avoidance of capital gain tax. Using our original example (and assuming that the gifted property can be deducted at fair market value), the donor sells the $1,000,000 property to the charity for $800,000 and receives a $200,000 charitable income tax deduction. If instead, the donor sold the property for $1,000,000 and then gave the charity $200,000 out of the proceeds of the sale, the donor would also generate the same $200,000 charitable income tax deduction. However, the capital gain tax consequences of the two transactions differ. As calculated previously, the bargain sale results in a $400,000 capital gain (i.e., $800,000 received from the charity – 80% of the $500,000 basis). If instead the donor were to sell the property at its fair market value and then make a gift to charity out of the proceeds, the donor would recognize a $500,000 gain (i.e., $1,000,000 received from the sale - $500,000 basis). Both transactions result in the transfer of $200,000 of benefit to the charity. Both transactions result in the donor keeping $800,000 (pre-tax) from the sale. However, the bargain sale generates $400,000 of capital gain where the sale followed by a gift generates $500,000 of capital gain. This benefit results from the same principle discussed in previous chapters; it is better to donate appreciated assets (when such assets can be deducted at fair market value) instead of cash. A gift of cash generates a single tax benefit: a charitable income tax deduction. A gift of appreciated property generates two tax benefits: a charitable income tax deduction and avoidance of capital gains tax. The bargain sale, when used with appreciated property, results in the same double tax benefit for the “gift” portion of the transaction. |
| A donor should not give depreciated property. Instead, the donor should sell the depreciated property, claim a loss for tax purposes, and then donate the proceeds of the sale to charity. The same principle applies to bargain sales. A donor should not make a bargain sale with depreciated property, but should instead sell the depreciated property for its fair market value, claim a loss for tax purposes, and then donate some portion of the proceeds of the sale to charity. A tax loss is valuable. It can be used to offset other gains and thereby reduce the taxes owed. Giving depreciated property needlessly eliminates this tax benefit. |  |
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It is usually undesirable to give debt-encumbered property to charity because the donor will be treated as having received income from the charity in the amount of the debt attached to the gifted property. In some cases, it may be possible to shift the debt to other assets so that the property gifted to charity will have no debt encumbrances. This produces a much more attractive tax result. |
| Suppose that a donor owned three pieces of land. Each property was worth $100,000, had been originally purchased for $50,000 more than a year ago, and had a $50,000 mortgage. The donor could choose to give debt-encumbered property to the charity. However, giving debt-encumbered property to a charity is treated as a bargain sale where the donor receives debt relief in exchange for the gift. (This is true regardless of whether or not the donor actually remains liable for the debt.) Consequently, each gifted property would generate a $50,000 charitable income tax deduction ($100,000 property value - $50,000 “debt relief”) and a $25,000 capital gain ($50,000 “debt relief” received – 50% of the $50,000 cost basis). In order to generate a $100,000 gift to charity, the donor would need to give two such properties, generating a $100,000 charitable income tax deduction and $50,000 of capital gain. There is, however, a much more advantageous way to make such a charitable gift if the debt attached to the properties could be shifted. |  |
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If the donor were able to transfer the debt from one property over to the remaining two properties, and then donate the single debt-free property to charity, the tax consequences are much better. (The likely process of such debt transference would be to refinance the remaining two properties to increase their debt from $50,000 to $75,000, using the proceeds from this refinancing to pay off the debt on the property to be gifted.) Gifting this debt-free property to charity results in the same $100,000 charitable income tax deduction as in the previous transaction involving the gifting of two debt-encumbered properties. It also leaves the donor with the identical $50,000 of remaining equity as in the previous transaction. The only difference is that instead of recognizing $50,000 of capital gain as in the previous transaction, the donor recognizes no capital gain from this alternative transaction. By simply altering the process for making the gift, the donor has received a substantially improved tax result. |
| Let’s now examine a few interesting cases involving the bargain sale rules. |  |
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In the case of Browning v. Commissioner (109, T.C. 303, 1997), the taxpayer sold a conservation easement on his farm to the county for $309,000. A conservation easement prevents the land from being developed to its highest potential in order to maintain the natural or agricultural state of the land. Such conservation easements reduce the value of the land, and are, consequently, valuable property rights. The taxpayer indicated a desire to benefit the county and the county’s conservation easement program in his decision to sell the conservation easement to the county for $309,000. The $309,000 sale price was based upon the standard rate at which the county agreed to pay for such conservation easements. The taxpayer obtained a qualified appraisal for his conservation easement rights of $518,000. The taxpayer claimed a charitable income tax deduction of $209,000 (i.e., $518,000 fair market value less the $309,000 sale price). The tax court ruled that this was an appropriate deduction because the donor sold a property right to the county for less than its fair market value with the intent of benefiting the county’s program. (Charitable gifts can include gifts to government entities as well as charitable organizations.) Note that this result happened even though the recipient organization did not necessarily believe that it was engaging in a bargain sale. The only requirements were that the donor sold the item for less than fair market value to the charity/government with the intent of benefitting the charity/government. |
| In a more extreme case (Consol. Investors Group v. Commissioner, T.C. Memo, 2009-290) a taxpayer was engaged in extended negotiations with the highway department over the sale of land to be used in the construction of a new road. These negotiations did not go well. The landowner believed the land to be worth far more than the highway department was willing to pay, and this belief was supported by an appraisal. As a result of the failure to reach an agreement, the highway department sued to take the land by force through eminent domain. In settlement of the contentious lawsuit, the taxpayer agreed to take an amount that was greater than the highway department’s earlier offers but less than appraised amount. Throughout the process, the highway department strongly disagreed with the high appraisal valuation obtained by the taxpayer. Nevertheless, after settling the lawsuit, the taxpayer claimed a charitable income tax deduction for the difference between the appraised value and the amount ultimately received from the highway department. The tax court found that the taxpayer’s appraisal was appropriate, meaning that the taxpayer received less than the fair market value in exchange for the land. Importantly, in the early negotiation period of this case the taxpayer had sent communication to the highway department referencing an interest in a sale or “contribution/sale.” The court indicated that this communication established the donor’s charitable intent in benefitting the highway department. Thus, despite the recipient’s vociferous contention that they had paid fair market value and that there was no bargain sale, the taxpayer/donor was allowed to deduct the difference between the appraised value and the amount received from the government entity. This is an extreme case showing that it is not the charitable recipient’s intent or belief that matters, but only that the donor sold property to the charity for less than fair market value with the intent of making a partial gift to the charitable entity. |  |
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As mentioned previously, understanding the tax consequences of bargain sale gifts serves two purposes. First, traditional bargain sales can be a useful charitable planning device. As contrasted with selling at fair market value and then making a gift out of the proceeds of the sale, a bargain sale gift can result in lower capital gain taxes. Second, other types of more complex charitable planning, such as Charitable Gift Annuities, are themselves forms of bargain sales. Thus, understanding the tax rules for bargain sales is helpful in understanding the tax consequences for these more complex transactions, because the same principles will continue to apply. |
Russell James concludes his chapter on Bargain Sales.
