Tax and Philanthropic Benefits of Donating Valuable Real Estate

Maximize your tax planning with a bargain sale to a nonprofit organization

If you are interested in selling a valuable property but want another option to reduce your tax obligation, you may want to consider a bargain sale to a charitable organization.

Overview of a bargain sale

We frequently work with clients that own a valuable piece of real estate they intend to sell, resulting in not only significant proceeds but also a significant tax bill. There is another option that may help In certain scenarios, for an individual that has charitable desires, a bargain sale to a qualified nonprofit organization may be the perfect answer. If structured properly, a bargain sale can satisfy an individual’s desire to dispose of the property for cash proceeds as well as meeting their philanthropic objectives, all while minimizing the tax impact of such a transaction.

A bargain sale occurs when a taxpayer sells property to a charitable organization for less than its fair market value (FMV). The difference between the FMV and the amount realized, the “bargain element,” is intended to be a charitable contribution. If the taxpayer has both a charitable intent and a desire or need to raise cash at the same time, a bargain sale allows the taxpayer to capture the full amount of the property’s FMV at the time of sale while limiting the amount of taxable gain the taxpayer will recognize. If the sale to the charitable organization is for the property’s FMV, no charitable contribution element will be associated with the transaction. The transaction will be treated the same as a normal property sale, with the gain or loss determined in reference to the selling taxpayer’s basis. Assuming the transaction does have a charitable element, the contribution will first offset any ordinary income that the taxpayer has.

Calculating the gain recognized and charitable deduction elements

When calculating the gain recognized and charitable deduction elements of a bargain sale to a charity, the first step is to determine whether a charitable contribution is allowed. In that determination, the normal rules apply, including the percentage limitations. If a charitable contribution is allowed, then the special rules will be used to determine the amount of the contribution and the amount of gain to be recognized on the transaction. It is important to note that the bargain sale rules apply to the transaction even if the charitable contribution will not be deductible in the year of the sale, as long as the contribution is permitted to be carried over to succeeding tax years, regardless of whether it is actually deducted in a succeeding tax year. If a charitable contribution is not allowed, then the gain on the sale is computed under the normal rules for a property sale by subtracting the adjusted basis of the property from the sale price. If a charitable contribution is allowed, then the taxpayer will need to determine both the amount of the gain-on-sale element and the charitable deduction due to the bargain element.

To compute the gain on the sale, the taxpayer must apportion the adjusted basis of the property between the sale portion and the donated portion. The adjusted basis of the property that is sold or exchanged is the portion of the adjusted basis of the entire property that bears the same ratio to the adjusted basis as the amount realized bears to the FMV of the entire property. The gain on the sale is recognized under normal tax accounting rules, generally, in the year of the sale, irrespective of the fact that the contribution may have to be carried over to a future tax year. The charitable deduction amount will be the difference between the FMV on the date of the sale and the amount realized, with a potential adjustment if the property requires a reduction.

Bargain sale calculation example

In year 1, C purchases land for $40,000. In year 10, C sells the land, which now has an FMV of $100,000, to a charity for a total sale price of $50,000. The charitable deduction on the bargain sale is $50,000 (the difference between the FMV of $100,000 and the sale price of$50,000 — no reduction is required). The portion of the adjusted basis of the land that is allocated to the sale portion is $20,000 [(50,000 ÷ 100,000) × $40,000]. C will recognize a long-term capital gain in year 10 of $30,000 (the amount realized of $50,000 less the allocable adjusted basis of $20,000).

Bargain sale documentation

As is the case with most transactions, documentation of intent and the facts at the time of the transaction can significantly help support the taxpayer’s position if the IRS ever chooses to audit the transaction. If a taxpayer does choose to go down the bargain sale route, it will be important that the purchase and sale agreements document both the FMV at the time of the contribution and the seller’s donative intent. If the property sold at a bargain price would require a qualified appraisal if donated outright, the bargain sale element will not avoid the need to obtain the qualified appraisal. In the event the charitable contribution is greater than $5,000, the Form 8283, Noncash Charitable Contributions, attached to the donor’s tax return will need to include additional information to show that the contribution was part of a bargain sale.

Questions specific to your property? The Keiter Tax team is available to share their knowledge and insights on this and other tax planning and saving strategies. Contact your Keiter Opportunity Advisor | Email.