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As its name implies, a bargain sale occurs when a donor, who intends to make a charitable contribution, sells property to charity for less than its fair market value. This memorandum reviews the various types of bargain sales, the technical requirements for qualification, taxation of bargain sales, computation of charitable contribution deductions, and the application of the bargain sale rules to various types of planned giving vehicles.
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 of property to charity that is subject to an indebtedness thereby being relieved of the obligation.
Prior to the Tax Reform Act of 1969, bargain sales offered very generous income tax benefits. These benefits are illustrated by the following example:
Prior Law: Mr. Smith owns a painting for which he paid $10,000. The painting has recently been appraised at $20,000. Mr. Smith would like to contribute the painting to a museum, but recover his original purchase price. He enters into an agreement with the museum whereby the museum will pay $10,000 cash for the painting. The museum will then place the painting in its collection.
Mr. Smith claims a charitable contribution income tax deduction in an amount equal to the difference between the fair market value on the date of contribution and the purchase price paid by the charity. Additionally, in the absence of any rules to the contrary, Mr. Smith calculates gain based on a first-in-first-out (FIFO) accounting method. Because the amount paid by the charity does not exceed Mr. Smith's cost basis, he realizes no gain on the sale of the partial interest.
Concerned that donors were receiving a double tax benefit by recovering their basis in contributed property tax free and claiming a charitable deduction, Congress amended IRC §1011 by adding the following paragraph:
Sec. 1011. Adjusted basis for determining gain or loss
(b) Bargain sale to a charitable organization - If a deduction is allowable under section 170 (relating to charitable contributions) by reason of a sale, then the adjusted basis for determining the gain from such sale shall be that portion of the adjusted basis which bears the same ratio to the adjusted basis as the amount realized bears to the fair market value of the property.1
Current Law: For bargain sales of property to charity after December 19, 1969, the amount of gain realized by a donor is the amount that bears the same ratio to the gain that would have been realized if the entire property had been sold at its fair market value on the date of the bargain sale. With respect to the previous example, Mr. Smith is still entitled to a charitable contribution deduction of $10,000; however, he will also realize gain in the amount of $5,000. This amount is determined as follows:
|F||=||Fair Market Value||=||$20,000|
|B||=||Adjusted Cost Basis||=||$10,000|
|S||=||Sales Price (Amount Realized)||=||$10,000|
Basis Allocated to Sale = S * (B / F) = $5,000
Realized Gain = Amount Realized($10,000) - Basis Allocated to Sale ($5,000)
In order for a transfer to qualify for bargain sale treatment, it must produce a charitable contribution income tax deduction under IRC §170. If there is no deduction, no apportionment of basis to the amount sold is available and the seller realizes the entire gain.
For purposes of determining if a charitable income tax deduction has been produced, the percentage limitations do not apply. Therefore, even though a taxpayer may not be able to claim a charitable contribution deduction arising from a bargain sale in the year of the transfer and must carry over the deduction to the next tax year, bargain sale treatment is permitted. 2
Example: Mrs. Brown makes two charitable contributions during a tax year in which her contribution base3 is $100,000. The first contribution is $40,000 cash made to a public charity. The second contribution consists of a bargain sale of long-term capital gain property to the same organization in which case a $30,000 contribution deduction is produced.
Under the ordering system of IRC §170 and the regulations, current year contributions of 50%-type property are allocated first in determining a donor's allowable charitable contribution deductions for the year. Contributions of 30%-type property are allocated next. In the present case, the donor must allocate the $40,000 cash gift. The remaining $30,000 deduction, applicable to the bargain sale, must be carried forward as an excess contribution into the following tax year. The sale will still qualify for bargain sale treatment.
A second situation that may delay a charitable contribution deduction involves the transfer of a future interest in tangible personal property. For example, if an individual transfers tangible personal property to a charitable remainder trust, no deduction is permitted until the expiration of all intervening interests in the property retained by the grantor.4 In other words, the deduction is not triggered until the property is sold from the trust.5 The sale and deduction could, therefore, occur in a future tax year.
Example: Mr. Green owns a classic automobile having a fair market value of $500,000 and an adjusted basis of $100,000. An automobile museum would like to add the car to its collection. Mr. Green would like to sell the car to museum, recover his cost basis and convert the remainder into a retained life income. The Museum proposes a combination of bargain sale and charitable remainder unitrust.
Under the proposed arrangement, the museum will purchase a 20 percent interest in the automobile for $100,000. Mr. Green will contribute the remaining 80% to a charitable remainder unitrust, after which, the museum will purchase the remaining interest from the trust. The purchase from the trust, however, is not accomplished in the same year as the initial 20 percent purchase.
Under this fact pattern, Green will recognize gain in the amount of $80,000 in year one. Green's charitable contribution deduction attributable to the contribution to the unitrust will not, however, be available until year two.
Even though the charitable contribution deduction is not available in the same year as the bargain sale, the irrevocable transfer to the charitable remainder trust does take place in the same tax year. Accordingly, bargain sale treatment is available to the transfer.
Application of Reduction Rules
Bargain sale treatment is not available if a charitable contribution deduction is denied by virtue of the reduction rules of IRC §170. Under current law, and using commonly gifted assets, the chances of this happening are remote, however. In order for the reduction rules to entirely eliminate any charitable deduction the property would require a zero dollar cost basis and produce 100% ordinary income if sold. Accordingly, as long the property subject to the sale has any basis, the transfer will qualify for purposes of this rule for bargain sale treatment. As discussed below, the reduction rules will limit the amount of charitable contribution deduction the donor can claim, however.6
Special Rules for Transfers of IRC §170(e) Property
When IRC §170(e) property is transferred to charity, the amount of the charitable contribution income tax deduction is reduced by the amount that would have been ordinary income or long-term capital gain had the property been sold on the date of contribution.7 There are four types of property that are considered IRC §170(e) property:
- Property that if sold would produce ordinary income8
- Tangible personal property put to an unrelated use by the charitable donee (regardless of holding period)9
- Long term capital gain property (other than publicly traded securities for which market quotations are readily available)10contributed to a private nonoperating foundation,11 and
- Property that would not otherwise be considered 170(e) property (e.g. long-term capital gain property) contributed to a public charity (as described in IRC §170(e)(1)(B)) for which the donor makes a special election to have treated as 170(e) property12
In all cases, the deduction for 170(e) property is limited to the lesser of the property's fair market value on the date of contribution or the donor's adjusted cost basis.
Example: Mrs. Green purchased publicly traded stock on January 1 for $10,000. On July 1, she makes a bargain sale of the stock to a charitable organization for $10,000. On the date of sale, the stock has a fair market value of $50,000.
Under the bargain sale rules, Mrs. Green will recognize $8,000 of short-term capital gain on the bargain sale. Furthermore, her gross charitable contribution income tax deduction of $40,000 must be reduced by the amount that would have been short-term capital gain (ordinary income) had she sold the contributed portion on the date of the gift. In this case, had she sold $40,000 of stock, she would have recognized a $32,000 short-term capital gain. Accordingly, her deduction will be reduced by this amount to $8,000.
Blended Ordinary Income and Capital Gain Property
When property is transferred which if sold on the date of contribution would have produced a blending of ordinary income and capital gains, such as would be the case with property subject to depreciation recapture, the amount of ordinary income and capital gains shall be realized in the same ratio as they bear to the entire fair market value of the property.13
Example: Mr. Brown owns property worth $100,000, which if sold at its fair market value would produce $25,000 of ordinary income and $25,000 of long-term capital gain. Mr. Brown sells the property to charity for $50,000. In this case, he recognizes $12,500 of ordinary income and $12,500 of long-term capital gain pursuant to the bargain sale.
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.
The phrase "charitable contribution," as used in section 170, is synonymous with the word "gift."14 A gift is generally defined as a voluntary transfer of property by the owner to another without consideration.15 This definition, however, does not refer to consideration in a common-law sense, but rather in a more colloquial sense.16 "If a payment proceeds primarily from the incentive of anticipated benefit to the payor beyond the satisfaction which flows from the performance of a generous act, it is not a gift."17
The courts have probed more than the subjective attitude of the donor and the extent to which public-spirited and charitable benevolence prompted the transfer. Their inquiries have sought to expose the true nature of the transaction: whether the gift was made in expectation of the receipt of certain specific direct economic benefits within the power of the recipient to bestow directly or indirectly, which otherwise might not be forthcoming.18
In Stubbs v. United States, the taxpayer dedicated a strip of land for use as a public road in order to facilitate his efforts to have his remaining land rezoned for use as a trailer park. The Court of Appeals for the Ninth Circuit, in affirming the District Court, held that the primary incentive of the taxpayer in making the transfer was to enhance the value and use of his remaining property and to obtain the desired zoning permits. Consequently, the claimed charitable contribution deduction was denied.19
Because bargain sale transactions frequently involve an actual payment by the purchasing charity that often involves negotiation, determining a taxpayer's incentive, motive, and purpose for making a gift is a factual problem. 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.
Like-Kind Bargain Exchanges
Coincidentally, the two Revenue Rulings that address a like-kind bargain exchange of property both involve timberlands. In Rev. Rul. 78-163, a taxpayer that is a producer of forest products proposes to exchange timberland worth $400,000 and having an adjusted cost of basis of $50,000 for bare land owned by the state that is worth $100,000. The state is a qualified charitable organization under IRC §170(c)(1). No money will change hands and there are no strings attached to the transaction.
Under IRC §1031(a), no gain or loss is recognized on the exchange of the properties since they are of like kind to be held for investment or productive business use. However, because the transaction involves a bargain sale, the basis in the property received from the state by the taxpayer must be determined under the rules of IRC §1011(b). The amount of charitable contribution deduction and the basis in the new property is calculated as follows:
|F||=||FMV of property transferred by taxpayer||=||$include:ts-xa$$400,000|
|B||=||Basis of property transferred by taxpayer||=||$include:ts-xa$$50,000|
|N||=||FMV of property received by taxpayer||=||$include:ts-xa$$300,000|
Charitable contribution deduction = F - N
Basis of New Property = (B / F) x N = $12,500
Rev. Rul. 76-253 presents an interesting twist on the exchange of timberland. In this very specific fact pattern, a corporation proposes to exchange timberland for timberland of lesser value owned by the state. The corporation also proposes to retain the timber cutting rights in the property it has transferred. Under IRC §1031(a), no gain or loss is recognized on the exchange of the properties since they are of like-kind to be held for investment or productive business use.20
Under normal circumstances, the transfer of an undivided portion of the taxpayer's entire interest in property to a state, accompanied by donative intent on the part of the donor gives rise to a charitable deduction. In this case, however, the retention of timber cutting rights on the transferred property represents a substantial retained right and therefore constitutes a nonqualified gift of a partial interest; thus, no charitable contribution deduction is allowed. In the absence of a charitable contribution deduction, the bargain sale rules do not apply.21
Bargain Sales of Debt Encumbered Property
When debt encumbered property is transferred to charity by outright gift, the entire amount of the indebtedness is considered an amount realized by the donor for purposes of the bargain sale rules. The amount of the realized gain is calculated as if the donor had received cash in the amount of the indebtedness. Rev. Rul. 81-163 describes the computation as follows:22
During the taxable year, an individual taxpayer transferred unimproved real property subject to an outstanding mortgage of 10x dollars to an organization described in section 170(c) of the Internal Revenue Code. On the date of transfer the fair market value of the property was 25x dollars, and the taxpayer's adjusted basis in the property was 15x dollars. The taxpayer had held the property for more than one year and made no other charitable contributions during the taxable year. The property was a capital asset in the taxpayer's hands. Thus, under the provisions of section 170 the taxpayer made a charitable contribution to the organization of 15x dollars (25x dollars fair market value less 10x dollars mortgage). LAW AND ANALYSIS
Section 1011(b) of the Code and section 1.1011-2(b) of the Income Tax Regulations provide that, if a deduction is allowable under section 170 (relating to charitable contributions) by reason of a sale, the adjusted basis for determining the gain from the sale 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 fair market value of the entire property.
Section 1.1011-2(a)(3) of the regulations provides that, if property is transferred subject to an indebtedness, the amount of the indebtedness must be treated as an amount realized for purposes of determining whether there is a sale or exchange to which section 1011(b) of the Code and section 1.1011-2 apply, even though the transferee does not agree to assume or pay the indebtedness.
Because the outstanding mortgage of 10x dollars is treated as an amount realized, the taxpayer's adjusted basis for determining gain on the bargain sale is 6x dollars (15x dollars adjusted basis of the entire property X 10x dollars amount realized 25x dollars fair market value of the entire property).
HOLDING The taxpayer recognizes long-term capital gain of 4x dollars (10x dollars amount realized less 6x dollars adjusted basis) on the bargain sale of the property to the charitable organization.
The bargain sales rules apply equally to recourse and nonrecourse indebtedness. In Brown v. Comm., the petitioner argued that the bargain sale rules should not apply to a contribution of computer equipment subject to nonrecourse indebtedness because the contributed property was not subject to the at-risk rules of IRC §465. The court rejected the petitioner's argument based on the fact that debt is included in the basis of the contributed property notwithstanding any limitations imposed by IRC §465; accordingly, the indebtedness should also be included in calculating gain.23
Possible Unrelated Business Income on Sale of Property by Donee
When a charitable donee accepts a transfer of property subject to a bargain sale, the basis of the property in the hands of the charity must be allocated between the portion received as a gift and the portion that was purchased.24 With respect to the portion purchased, the basis is equal to the purchase price. With respect to the amount received by gift, the basis is carried over in direct relation to the ratio of the donor's basis in the entire property on the date of transfer.
Example: Mr. Jones makes an outright contribution of a parcel of raw land that has a fair market value of $100,000, a cost basis of $50,000, and an indebtedness of $25,000. Under the bargain sale rules, the indebtedness is treated as an amount realized by Mr. Jones for purposes of the bargain sale rules.
For the purpose of determining the basis of the property in the hands of the charity, the indebtedness is considered an amount paid by the charity. Accordingly, the basis allocable to the portion of the transaction is $25,000. The basis allocable to the remaining $75,000 is determined by multiplying this amount by the ratio of Mr. Jones' basis in the property to the entire fair market value of the property on the date of transfer. This basis attributable to the contributed portion would be $37,500 ($75,000 x ($50,000 / $100,000)). The total basis of the property in the hands of the donee is $62,500 ($37,500 + $25,000).
Under normal circumstances, gain from the sale of long-term capital gain property by a charitable organization is excluded from the computation of unrelated business income.25 Therefore, the tax basis of the property in the hands of the charity would be irrelevant. However, this exclusion does not apply if the property is debt-financed.
When property (no matter how acquired) is acquired by a charitable organization subject to mortgage or other similar lien, the amount of the indebtedness secured by such mortgage or lien is considered as an indebtedness of the organization incurred in acquiring such property even though the organization does not assume or agree to pay such indebtedness. Therefore, indebtedness of property subject to recourse or nonrecourse is considered an "acquisition indebtedness" of the acquiring organization.
If, however, an organization acquires property by gift that is subject to a mortgage that was placed on the property more than five years before the gift, and the property was held by the donor more than five years before the gift, the indebtedness secured by the mortgage will not be treated as acquisition indebtedness during a period of ten years following the date of such gift. This exception, however, does not apply if the organization, in order to acquire the equity in the property, assumes and agrees to pay the indebtedness secured by the mortgage, or if the organization makes any payment for the equity in the property owned by the donor.26
If the recipient organization is required to make payments on the mortgage until it disposes of the property, or if the organization purchases an equity portion of the property from the donor, the exception does not apply. Accordingly, if the property constitutes debt-financed property, any gain from the sale of the property will be considered debt-financed income and, based upon the appropriate formula, will be included in the computation of the organization's unrelated business taxable income.
Avoiding Acquisition Indebtedness
If the property qualifies for the "five and five" rule as described above, an organization may be able to avoid having acquisition indebtedness by requiring that as a condition of the gift, the donor remain personally responsible for making the mortgage payments until the property is sold. If, however, the donor defaults on the obligation, the charity may be forced to step in and make payments thereby triggering the acquisition indebtedness and taxable gain on the subsequent sale of the property.
There may, however, be another and potentially safer alternative to ensure the avoidance of gain on the sale of debt encumbered property. In Rev. Rul. 76-95, a charitable organization owned a 35 percent interest in rental real property. The remaining 65 percent of the property was owned by private individuals. The property was subject to a mortgage of $1,000,000 of which the organization's share was $350,000.
In order to liquidate its share of the mortgage, the organization entered into two agreements, one with the financial institution that holds the mortgage and the other with the co-owners of the property. Under the terms of the first agreement, the organization prepaid its proportionate share of the mortgage indebtedness in exchange for the mortgagee's release of the organization from any further payment obligation under the mortgage. Under the second agreement, the other co-owners of the property released the organization from all payment obligations associated with the mortgage indebtedness. At the time of the second agreement, the releasing co-owners were clearly able to meet the remaining payment obligations.
In this case, the Service ruled that even though the entire property was still encumbered by the lien of the mortgagee, the organization took steps necessary to release itself from all indebtedness under the mortgage. By liquidating its proportionate share of the outstanding indebtedness and by securing releases of its financial obligations under the mortgage from the mortgagee and the other co-owners, the organization satisfied the full amount of its indebtedness. Accordingly, the organization had no acquisition indebtedness within the meaning of section 514(c)(1) of the Code with respect to its undivided interest in the property.27
Bargain Installment Sales
If property is sold to charity for less than its fair market value in exchange for an installment note, can the gain attributable to the bargain sale be reported using the installment method? Properly structured, the answer is yes.
In Rev. Rul. 79-326, a taxpayer made a bargain sale of real property to an educational organization. At the time of the transfer the property was subject to an existing mortgage. The organization made a cash down payment, executed a new mortgage to the seller, and assumed the existing mortgage. The Service ruled that the transaction would qualify for bargain sale treatment. Further, for purposes of determining the taxation of the mortgage payments to the taxpayer, the amount of the assumed mortgage in excess of the taxpayer's basis allocated to the amount realized in connection with the bargain sale is included for the purpose of determining the taxation of payments received by the taxpayer in the year of sale and the total contract price.28
In a request for private ruling, a taxpayer proposed to contribute a one-half interest in real property to a charitable remainder unitrust and concurrently sell the remaining one-half interest to the charitable remainderman of the trust. The Service ruled that the transfer to the charitable remainder trust would qualify for charitable deduction purposes and the portion sold would qualify as a bargain sale. Based on the facts submitted and the installment sale rules that existed at the time of the ruling, the Service concluded that the seller could report gain realized from the sale of the land as the installment payments were received.29
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. Lastly, issues have been raised regarding the possible application of the debt-financed property rules to such a charitable bargain installment sale.
Fact Specific Transactions
Gift of Option to Purchase Stock in Corporation
In Rev. Rul. 75-348, a publicly traded corporation made a pledge to an educational institution in which the institution could purchase a specified number of shares of the corporation at any time during a specified period at a price set forth in the pledge agreement. It was anticipated that if the price of the stock grew beyond the strike price, the institution would exercise its purchase option.
The Service ruled that the corporation would be entitled to a charitable contribution income tax deduction in the year the institution exercised the option in an amount equal to the difference between the strike price and the fair market value of the stock on the date of exercise. Further, IRC §1032 provides that no gain or loss shall be recognized to a corporation on the receipt of money or other property in exchange for stock (including treasury stock) of such corporation. Accordingly, the bargain sale rules do not apply to such transactions.30
Bargain Sale of Company Stock Followed by Redemption
In a private letter ruling, a company president proposed to sell company stock that he owned personally to a charitable organization at a discount; after which, the company could redeem the shares at their fair market value. The charity was not bound, however, to offer the shares for redemption and the company was not bound to redeem them.
The Service ruled that the president would receive a charitable contribution income tax deduction for the difference between the selling price of the stock and its fair market value on the date of sale. Further, any subsequent redemption by the company would not result in dividend treatment to the president nor would it cause the company to recognize gain or loss. Gain to the president was to be determined under the standard bargain sale rules.31
The following scenario illustrates the importance of donative intent and following the terms of a transaction for which the IRS has issued a favorable advance ruling:
In 1983, the IRS approved an arrangement whereby a company's sole shareholder would sell 591 shares of stock, having a fair market value of $12,000 per share, to a charitable organization for $10,000 per share. The total purchase price to the charity was $5,910,000 for which it would make a cash down payment of $1,000,000 and give the company a ten-year note bearing an interest rate of 17%. Although the company was under no obligation to do so, it was also represented that the company might offer to redeem the shares owned by the charity for $12,000 each, for a cash down payment of 10 percent, or $709,200, and a note bearing the same terms as the note held by the charity, for the difference of $6,382,000.
The Service ruled:
- that the company would be entitled to a charitable contribution income tax deduction in an amount equal to the difference between the fair market value of the stock and the sales price;
- that gain on the sale would be determined under the bargain sale rules;
- that the redemption by the company of the shares would be a complete termination of the charity's interest and would be treated as a distribution in full payment in exchange for the stock redeemed;32
- that any gain realized by the charity on the redemption would be capital gain;
- that no gain would be recognized by the company upon the redemption; and
- that the remaining shareholders would not be deemed as having received a constructive dividend upon redemption by the company.
After the Service issued the ruling, however, a third party appraiser valued the company stock at between $19,000 and $21,000 per share. The parties therefore agreed to reduce the number of shares involved in the transaction. At the same time, the charity became concerned that because the shares were debt-financed, the gain it realized on the redemption by the company would be considered unrelated business taxable income under IRC §§511 and 514. The charity, therefore, requested a change in the transaction.
In December of 1982, the company sold 374 shares to the charity for $19,000 per share for which the charity made a down payment of $1,000,000 and executed a ten-year promissory note for the balance at 16 percent. On the same day, the company's sole shareholder made an outright gift of 62 shares to the charity.
During the following month, the company redeemed all 436 shares owned by the charity for $19,300 per share. As consideration, the company made a cash down payment of $1,000,000 and executed a ten-year promissory note at 16 percent.
In technical advice, the Service ruled that pursuant to Rev. Proc. 82-37, the facts as developed differed so materially from the facts on which the original ruling was based, the prior ruling could be modified or revoked. In the actual transaction, the Service ruled that the charity had paid fair market value for the 374 shares and had received an independent gift from a different donor of 62 shares, followed by a redemption. As far as the company was concerned, because of the insubstantiality of the valuation, the Service ruled the transaction lacked the requisite donative intent. Hence, no charitable deduction was given the company. And with no deduction, bargain sale treatment was unavailable. The shareholder was allowed a charitable deduction for the value of the 62 shares, however.33
Bargain Sale of Limited Partnership Interest
Rev. Rul. 75-194 examines the application of the bargain sale rules to the contribution by a limited partner of a partnership interest in which the underlying assets are subject to nonrecourse indebtedness.
In the facts presented in the ruling, the partner's proportionate share of the value of the partnership assets was greater than the partner's share of partnership liabilities. Furthermore, due to partnership losses, the partner's adjusted basis for his partnership interest was less than his share of the partnership liabilities. At the time of the contribution, there were no unrealized receivables or inventory items as described in IRC §751.
The ruling held that since the partner had equity in his interest, a charitable deduction was allowable under IRC §170. At the same time, the partner would realize his share of the partnership liabilities for the purpose of determining gain under the bargain sale rules. Furthermore, because there were no receivables or inventory items, all gain arising from the bargain sale would be considered long-term capital gain.34
Bargain Sale of Inventory for Scientific Research
Normally, a gift of inventory is limited for charitable contribution deduction purposes to the lesser of fair market value or the cost of goods sold. However, IRC §170(e)(4) provides a special exception that permits a donor who creates and contributes "qualified research property" to an institution of higher education or scientific research that uses the property for research purposes to claim a charitable contribution income tax deduction based on the lesser of 1) the corporation's cost basis plus 50 percent of the difference between the cost basis and the list price, and 2) 200 percent of cost basis.
In Ltr. Rul. 8845036, a company that manufactured precision electronic instruments wished to make a grant of equipment to a university for the purpose of establishing an instructional and research library. The company could not afford to make an outright gift of the equipment; therefore, the company agreed to sell the equipment to the university for 20 percent of the equipment's list price.
The equipment and transfer met all of the requirements of IRC §170(e)(4)(C). Accordingly, the Service ruled that the company would be able to claim a charitable contribution deduction in an amount described above. Furthermore, the sale would qualify for bargain sale purposes.35
Retention of Insubstantial Interests
In Glick v. Comm., the taxpayer transferred a farm to charity by outright gift while retaining the right to farm and harvest a small portion of the property. The Tax Court ruled that because the cost of production exceeded the fair market value of the crop, the retained right had no value; accordingly, the transfer was not considered a bargain sale.36
As previously mentioned in the discussion of "like-kind bargain exchanges," Rev. Rul. 76-253 disallowed both a charitable deduction and bargain sale treatment on a like-kind bargain exchange of timberland in which the taxpayer retained the cutting rights to the property transferred. Unlike the previous example, the retention of timber cutting rights was indeed a substantial right that disqualified the transfer on the grounds that it was a nonqualified gift of a partial interest.37 In the absence of a qualified charitable contribution, bargain sale treatment was also disallowed.
In Stark v. Comm., the court ruled that the taxpayer's 25-year retained mineral rights to property donated to the U.S. Forest Service were insubstantial because expert testimony revealed that there were no known minerals on the property and the chances of exploration were negligible.38
Gain Arising from Bargain Sale of Personal Residence
Can capital gain realized by virtue of a bargain sale of a personal residence be excluded pursuant to the limitations of IRC §121? For example, suppose a married couple make an outright gift of their personal residence to charity; however, by virtue of the indebtedness secured by the property, they realize a $500,000 gain under the bargain sale rules. Can the couple use their $500, 000 capital gain exclusion to offset the gain?
The Service ruled privately that gain arising from the bargain sale of a principal residence qualified for exclusion under prior IRC §121 and for deferral under prior IRC §1034.39 Section §121 was revised and §1034 was repealed with TRA '97; however, the application of the ruling to IRC §121 would seem to be analogous.
Effect of Bargain Sales on Split Interest Charitable Gifts
Charitable Gift Annuities
Transfers of property to charity in exchange for a charitable gift annuity may give rise to the bargain sale rules. A charitable gift annuity is generally described as a transaction in which an individual transfers cash or other property to a charitable organization in exchange for the organization's promise to make fixed annuity payments for the life of one or more annuitants. The transaction consists of part outright gift and part purchase of an annuity contract; thus, the present value of the annuity is considered an amount realized by the donor for purposes of applying the bargain sale rules. In addition, the transfer of debt-encumbered property to charity in exchange for a charitable gift annuity carries additional bargain sale consequences.
The application of the bargain sale rules to charitable gift annuity transactions is described in detail in the Gift Annuity technical report.
Pooled Income Funds
The transfer of a donor's entire interest in property to a pooled income fund is not considered a bargain sale unless the property is subject to an indebtedness.40 A detailed discussion of the application of the bargain sale rules to transfers of debt-encumbered property to pooled income funds is found in the Pooled Income Fund technical report.
Charitable Remainder Trusts
Like pooled income funds, a transfer of a donor's entire interest in property to a charitable remainder trust is not considered a bargain sale unless the property is subject to an indebtedness. However, unlike pooled income funds, 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. As mentioned earlier, the Service ruled that an arrangement whereby a taxpayer sold a portion of real property directly to a charity and transferred the remainder to a charitable remainder trust, which in turn sold the property to the charity, qualified for bargain sale purposes.41
Gifts of a Remainder Interest in Personal Residence or Farm
The gift of a remainder interest in a personal residence or farm to charity (also known as a life estate agreement) is not considered a bargain sale unless the property is subject to an indebtedness. If the property is subject to an indebtedness, however, the entire amount of the indebtedness is considered realized by the taxpayer for purposes of the bargain sale rules.42
In a traditional life estate agreement, the donor contributes the entire remainder interest in the property to charity. However, the donor is not required to do so. As an alternative, a prospective donor can offer to sell a portion of the remainder interest to the charity in conjunction with a contribution of the remaining portion. In such cases, the charity may offer payment in the form of cash, an installment note, or a charitable gift annuity (if available). In essence, the concept represents a sophisticated form of bargain sale.43
Because the purchasing charity must make payment from sources exclusive from the contributed remainder interest, acceptable candidates for this technique are generally older and have property that is debt-free or substantially debt-free. For additional reading, see the Life Estate Agreements technical report.
Charitable Lead Trusts
Does the transfer of debt-encumbered property to a charitable lead trust cause the grantor to realize gain under the bargain sale rules? IRC §1011(b) provides --
If a deduction is allowable under section 170 (relating to charitable contributions) by reason of a sale, then the adjusted basis for determining the gain from such sale shall be that portion of the adjusted basis which bears the same ratio to the adjusted basis as the amount realized bears to the fair market value of the property.
Although the regulations provide that a transfer of debt encumbered property to charity in exchange for a charitable gift annuity requires the donor to treat the indebtedness as an amount realized for purposes of the bargain sale rules, no guidance is given regarding a contribution of an income interest such as occurs with a charitable lead trust.44
In the case of a transfer to a nongrantor charitable lead trust (i.e., a trust for which the grantor is not deemed the owner of the trust's income), no deduction is allowable under IRC §170. Therefore, the bargain sale rules should not apply to such transfers. With respect to transfers to grantor charitable lead trusts for which a deduction under IRC §170 is produced, such transfers would, if based solely on this criteria, seem to trigger the bargain sale rules. Gifts of an income interest are, however, distinguishable from both outright gifts and gifts of a remainder interest.
When debt-encumbered property is transferred by outright gift to charity, the donor is relieved of the obligation. Such relief is considered income. The same theory holds true with a gift of a remainder interest to charity. Although there is an intervening income interest, the debt is ultimately transferred to charity.
In the case of a grantor lead trust, the grantor is treated as the owner of the income interest. Furthermore, the trust corpus (remainder interest) and, therefore, the indebtedness is never transferred to charity. Provided the trust takes the property "subject to" and does not "assume" the indebtedness, it would seem plausible that the transfer would not be considered a bargain sale. The IRS has not, however, issued any public or private rulings on this issue.
Reg. §1011-2(a)(2); In Hodgdon v. Comm., 98 T.C. 424 (1992), the Tax Court ruled the taxpayer was subject to bargain sale treatment even though the charitable income deduction could not be fully utilized by the taxpayer in the year of the gift and during the subsequent five-year carryover period.back
Adjusted gross income without regard to NOL carryback into the contribution yearback
Ltr. Rul. 9452026back
See Estate of Bullard v. Comm., 87 T.C. No. 17 (July 31, 1986) which invalidated prior law.back
IRC §170(e)(1)(C)(iii); The special election is used frequently by taxpayers who contribute high cost basis assets to charity in order to obtain 50% limitation rather than 30% limitation treatment. If the donor's basis is equal to the fair market value, there is no reduction in the amount that can be claimed.back
Harold DeJong, 36 T.C. 896, 899 (1961), affd. 309 F. 2d 373 (C.A. 9, 1962); Jordon Perlmutter, 45 T.C. 311 (1965); James A. McLaughlin, 51 T.C. 233, 234 (1968), affirmed per curiam (C.A. 1, 1969, 23 A.F.T.R. 2d 69-1763, 69-2 U.S.T.C. par. 9467); Harold E. Wolfe, 54 T.C. 1707, 1713 (1970).back
Harold DeJong, supra at 899.back
Comm. v. Duberstein, 363 U.S. 278, 285 (1960); Harold E. Wolfe, supra at 1713back
Harold DeJong, supra at 899; Bogardus v. Commissioner, 302 U.S. 34, 41 (1937)back
Stubbs v. United States, 428 F. 2d 885, 887 (C.A. 9, 1970).back
See also Grinslade, Charles O., et al. v. Comm., 59 T.C. 566 (1973); Connell v. Comm., 51 T.C. 261, 265 (1986); Stark v. Comm., 86 T.C. 243 (1986); Rainier Cos. v. Comm., 36 T.C.M. 1404 (1977), 61 T.C. 68 (1973), rev'd, 538 F.2d 338 (9th Cir. 1975)back
Rev. Rul. 72-515, 1972-2 C.B. 466back
Rev. Rul. 76-253, 1976-2 C.B. 51back
Rev. Rul. 81-163; 1981-1 C.B. 433back
Brown, R. E., et ux. v. Comm., T.C. Memo 1996-325; See also Comm. v. Tufts, 461 U.S. 300 (1983); Ebben, et al. v. Comm, 86-1 USTC Para. 9250, 783 F2nd 906; Winston F.C. Guest et ux. V. Comm., 77 T.C. 9 (1981)back
Rev. Rul. 76-95, 1976-1 C.B 172back
Rev. Rul. 79-326, 1979-2 C.B. 206back
Ltr. Rul. 8042142back
Rev. Rul. 75-348, 1975-2 C.B. 75back
Ltr. Rul. 8213063back
Rev. Rul. 78-197, 1978-1 C.B. 83 (The Palmer Ruling)back
Ltr. Rul. 9203005back
Rev. Rul. 75-194, 1975-1 C.B. 80back
See also Ltr. Rul. 9528022back
Glick v. Comm., 73 TCM No. 65 (1997)back
Rev. Rul. 76-253, 1976-2 C.B. 51back
Stark, Nelda v. Comm., 86 T.C. No. 17 (March 3, 1986)back
Ltr. Ruls. 8615025; 7904074; 8221117back
Ltr. Rul. 8002034back
Ltr. Rul. 8042142back
Ltr. Rul. 9329017back
Ltr. Ruls. 8134106; 8806042back
Copyright 2009. Marc D. Hoffman. All rights reserved. Used by permission.