This third article in a series on real estate gifting issues covers bargain sales.
Commercial real estate professionals and their clients should consider all options when discussing the charitable donation of real property. Real Estate Gifting Realized, a new program launched by the CCIM Foundation, facilitates the donation of real estate to charitable organizations. A donation may be made directly to the CCIM Foundation or the Foundation can assist with the donation to a chosen charity.
A bargain sale takes place when a donor sells a property to a charitable organization and receives less than the fair market value in return. For a transaction to qualify for bargain sale treatment, the donor/seller must establish the intent to make a charitable gift prior to the transaction and the transaction must produce a charitable contribution income tax deduction under the Internal Revenue Code.
The amount that is less than fair market value is considered a charitable donation and the amount received by the donor is the amount used for taxable gain purposes. The donor benefits from the bypass of taxable gain on the gift portion and receives a charitable deduction on the gift portion. The donor, however, must recognize taxable gain on the value received. The adjusted basis in the property must be allocated between the part sold and the part contributed based on the fair market value of each. Internal Revenue Service Publication 526 provides information on calculating charitable contributions.
Bargain sales usually involve appreciated property. The charitable deduction may be reduced if the asset consists in part of ordinary income, such as real property subject to ordinary income recapture. Gifts of ordinary income property require that the gift portion claimed as a deduction be reduced to cost basis. Real property with accelerated depreciation will include an element of ordinary income for the excess of the accelerated over straight-line depreciation. This excess will lead to a reduction of the charitable deduction under ordinary income rules.
Since many bargain sales involve mortgaged property, it’s important to understand the implications. A donation or sale of mortgaged property may be taxable. When debt-encumbered property is transferred to a charity by outright gift, the entire amount of the indebtedness is considered realized by the donor for purposes of the bargain sale rules. The amount of realized gain is calculated as if the donor received cash in the amount of the indebtedness. This is true for both recourse and nonrecourse debt. The deduction is the excess of fair market value over the amount of the outstanding mortgage.
However, there may be a taxable gain. The IRS and the U.S. Tax Court treat the transferred mortgage debt as cash received in a part-gift, part-sale transaction and subject to the rules for bargain sales of appreciated property. Therefore, there may be a taxable gain if the transferred mortgage exceeds the portion of basis allocated to the sale part of the transaction. This is true even if the charity does not assume the mortgage.
Bargain sales can be very complicated and bring many variables into play. It is imperative that the donor’s advisers review the implications for the donor/seller to make certain that the donor/seller achieves both goals of providing a charitable donation and obtaining tax savings.
The rules on charitable deductions to qualified charities are very detailed and require review at the time a charitable donation is contemplated as the rules may change or be impacted by current tax court decisions and case law.
Mary Stark Hood, JD, CFP, is president of the Hood Group, which provides consulting services to business organizations and foundations. She currently serves as a consultant to the CCIM Foundation’s Real Estate Gifting Realized Program.