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Bargain Sale - "Overlooked and Under-Used Gift-Planning Arrangement"
The title says it all! In this edition of Gift Planner's Digest, Long Beach Memorial Medical Center Foundation's Jim Normandin shares his experiences in the use of the bargain sale as a means to help donors accomplish their personal and philanthropic planning objectives.
By James F. Normandin
James Normandin is Executive Vice President for Memorial Medical Center Foundation in Long Beach, California. With 28 years of experience in financial and estate planning, Jim markets, designs and implements a resource service to assist donors and their advisors on the best method of optimizing income and minimizing taxation, utilizing charitable tax planning techniques to fulfill philanthropic goals and objectives. In this fiduciary capacity the Foundation currently oversees $120 million in assets.
An Eagle Scout and a graduate of California State University of Long Beach, Jim is a co-founder and member of the faculty of the American Institute for Philanthropic Studies which awards a CSPG (Certified Specialist in Planned Giving) designation to all successful graduates. He is a Board member of Casa Theresa. Mr. Normandin can be reached at JNormandin@memorialcare.org
Our Transitional Rehabilitation program, an integral part of our Rehabilitation Hospital, has been renting space from Alan and Dorothy for some time. About fifteen months before the lease was to expire, we began looking for other options, and it was soon obvious our interests would best be served by remaining in the existing facility. We approached Alan and Dorothy about making a gift of the property and in exchange we would name the program in their honor. They didn't feel they could make a gift of the entire amount. We suggested a bargain sale - a "win-win" scenario that helped both sides. Not only did we purchase the property for a price significantly below market value, we secured our future and reduced our costs dramatically. In addition, Alan and Dorothy became philanthropists by contributing to the success of our program.
A bargain sale is a unique opportunity for non-profits to achieve significant outright gifts in support of their mission. This charitable planning technique is often overlooked and definitely underused, and has many applications. In short, a bargain sale is the purchase of property (securities, real estate, etc.) for less than its fair market value. In such case, the difference between the fair market value and the sales price constitutes a charitable gift. Thus, the donor/seller is able to recoup some cash, perhaps equal to their investment in the property, and use the balance as a charitable gift. This charitable gift can be outright or a gift in trust which may be designed to pay an income for the life or a term of years to the donor/seller or other. The most common type of bargain sale occurs when a donor makes an actual sale of property to charity in exchange for cash or an installment note. However, bargain sales can also arise when a donor transfers property to charity in exchange for like-kind property of lesser value, or when a donor transfers property to charity that is subject to an indebtedness, thereby being relieved of the obligation.
Gift in Trust
|Fair Market Value||$100,000||$100,000|
|Cash to Donor(s)||20,000||20,000|
|Gain Recognition *||16,000||16,000|
|Trust Income First Year||-0-||$ 5,600|
* When appreciated property is transferred subject to the Bargain Sale Rules, tax law requires that the sale price shall be allocated between the portion sold and that which is gifted. Reg. §1.170A-4(c)(4). The amount of gain recognized may be partially or wholly offset by the accompanying charitable deduction.
In addition to the requirement that a charitable deduction be produced under IRC §170, bargain sale treatment is available only to transactions in which the donor/seller establishes the intent to make a charitable gift prior to the transaction (See Exhibit A). This can be accomplished through a letter that expresses the wishes of the donor to sell the property to the Charity for less than its fair market value. Accordingly, bargain sale treatment may not be available to a transaction in which a taxpayer sells property to a charitable organization at a discount from its appraised fair market value after extensive negotiations, unless the differential in price and value are significant and the intent to make a charitable gift has been clearly evidenced in advance of the transfer.
Early in my career I was in a discussion with a couple whom had expressed an interest in the work of our organization. After significant fact-finding, I followed up with a proposal outlining the suggested method of giving. Following the presentation, I detected there was an interest in making the gift, but there was some reluctance to giving the entire asset. I closed the interview with?." perhaps Mr. and Mrs. Donor, the best way to accomplish your objectives would be to fund this charitable remainder trust with a 70% undivided interest in the property -- and Memorial Medical Center Foundation will bargain sale the balance."
Consider the installment bargain sale as an alternative where the sale price is paid in installments covering more than one year. This will create a source of income for the length of the installment agreement in a non-trust environment. As an example, donor owns a valuable piece of property worth $1 million. Donor wants the Hospital to have it ultimately, but is not in a position to make an outright gift. Rather, they would like a source of income for the next ten years based on a bargain sale price. Donor sells the property to the Hospital for $500,000 in exchange for a fully-amortized (considered non-amortized) note at the going interest rate for ten years.
Properly structured, the bargain sale shall be reported using the installment method. Taxpayers must be aware that if a sale of property, exclusive of a bargain to charity, would not qualify for installment sale reporting, neither will a bargain installment sale of such property to charity. Furthermore, if the sales contract does not carry a sufficient amount of interest, as described in IRC §483, a portion of the sales price may be recharacterized as unstated interest thereby reducing both the amount of charitable contribution deduction and the amount of gain that may otherwise qualify for reporting as long-term capital gain.
Bargain Sale Case Studies
Bargain Sale of Personal Residence
Consider Mr. and Mrs. Donor who approach your organization requesting you purchase their personal residence for $600,000, which has a current market value of $1.2 million with an adjusted cost basis of $200,000. Upon acceptance of this bargain sale, the Donors will have achieved a philanthropic goal of an outright gift of $600,000. Applying the bargain sale rules, the $600,000 received may be entirely tax-free by applying the Section 121 Exclusion. Under this exclusion, our couple can realize $500,000 of capital gain upon sale of a personal residence.
Gifts of a Remainder Interest in Personal Residence or Farm
In the traditional Life Estate Agreement, the donor contributes the property subject to their life estate and receives a charitable income tax deduction for the remainder interest passing to charity. As many of you know, it is possible to gift this remainder interest in exchange for a charitable gift annuity if offered by the organization. It is also possible for the donor to bargain sale their remainder interest. As an example, George and Lynn gift their $750,000 personal residence to the charity subject to a life estate. The present value of the remainder interest is equal to $208,241. The charity agrees to purchase this remainder interest in a bargain sale for $160,000. Again, this could be all cash or an installment note.
Charitable Remainder Trusts and Bargain Sales
Consider the case of Phil and Evelyn. They have an apartment house that has a current market value of $425,000, an adjusted cost basis of $12,000, and an outstanding mortgage of $80,000. They desire to transfer this property to a charitable remainder trust for the benefit of their children. Transfers of debt-encumbered property to a charitable remainder trust may cause it to be treated as a grantor trust and not a qualified charitable remainder trust, among other potential problems. Great care must be exercised prior to a contribution of debt-encumbered property and may not be recommended in many instances.
A meaningful solution was achieved when the charity purchased a 25% undivided interest for a bargain sale price of $85,000. This allowed Phil and Evelyn to pay off the mortgage followed by the gift of 100% of what they then owned - which was a 75% undivided interest in the subject property to their charitable remainder trust.
Phil and Evelyn will need a qualified appraisal to substantiate the fair market value of the property at the time it was gifted. Since their gift represents only a 75% undivided interest, they need to discuss with their tax counsel that the gift of a minority interest may give rise to a valuation discount. As such, they should ask the appraiser to provide a valuation as to a 75% undivided interest in the subject property. It should be pointed out that any discount taken will affect only the charitable income tax deduction available.
Like any charitable gift, the organization needs to evaluate the "business aspects" of accepting the gift. Beyond the philanthropic aspects of a bargain sale, prior to accepting the gift, you should have an accurate and realistic appraisal of the subject property. I also feel it is important that you get some professional opinions. In other words, when dealing with real estate, ask a couple of local real estate agents their opinion as to the fair market value of the proposed bargain sale property. Further, you should deal with an expert who deals with the type of property being considered (i.e., residential, multi-family, commercial, or retail). You should obtain from them their opinion of value, their recommendation as to listing price, approximate time on market, what they think it would sell for, and under what terms.
Another business aspect would be the holding cost. In other words, from the time you accept the property through subsequent resale and further, are the resources of your staff and their ability to provide expertise in this area adequate for the task. In short, be skeptical and look beyond. Is this a good business transaction for the charity?
Depending on the goals and the nature of the asset, a bargain sale has tremendous marketing appeal. The fact that a donor could recover their original investment in an asset, with an outright gift of their appreciation, is psychologically attractive. The installment bargain sale, while offering significant philanthropic and tax benefits, offers some other advantages. The terms of the note are specific and, at the death of the donor/grantor, the amount due under the note can continue for the benefit of their heirs or could be forgiven in favor of the charity. In closing, I encourage you to discuss this most flexible of gift-planning tools with your prospective donors for the benefit of your organization. You'll be glad you did!
Charitable Bargain Sale and Installment Note Agreement
On (date), (name), as trustees under Declaration of Trust dated April 8, 1976, Donor/Seller, and (charity), Donee/Buyer, hereby enter into this Charitable Bargain Sale Installment Agreement.
Charitable Bargain Sale
On this date, the (name) agree to sell to (charity) real property located in (county) at (address) with an appraised fair market value of (dollar amount) for an agreed upon purchase price of (dollar amount), intending to contemporaneously make a charitable gift to (charity) of (bargain sale amount).
The (name) represent and warrant that the property is free and clear of any mortgages, liens, encumbrances, and/or any undisclosed environmental liabilities, and agree to indemnify the (charity) should any costs, fees, and/or expenses arise in connection with this warranty.
The (charity) promises to pay the (name) the (dollar amount) purchase price together with (percentage) interest thereon over a period of (number) years as is evidenced by this unsecured installment note.
The annual payments will be (dollar amount) payable to (name) as Trustees of the Declaration of Trust dated (date) in monthly increments of (dollar amount) due on the (time frequency). The first payment shall be due on (date). The last payment shall be due on (date). Total payments over the term of this note will be (dollar amount).
The character of the monthly payments will be allocated as follows: (dollar amount) interest; (dollar amount) capital gain; and (dollar amount) tax-free return of principal.
In the event the (charity) is more than (number) days late in delivering a monthly payment, then a (dollar amount) late charge shall be added to the next monthly payment.
The (name) may sell, assign, or otherwise transfer this note, and shall promptly notify the (charity) of such an occurrence.
Should both (names) die before the termination of this note, the remaining payments shall continue to the survivor's estate or designated beneficiaries.
This note shall be governed and enforced under the laws of the State of (state).
Reprinted with permission. Copyright © 2001 Association for Healthcare Philanthropy. For more information on AHP, visit www.ahp.org/Pages/Home.aspx