What is a Bargain Sale to a Charitable Organization?

A bargain sale to a charitable organization is the sale of a good or service to a charitable organization for less than the fair market value of the good or service received. Donors often who wish to make a charitable donation to an organization in a form other than cash often use bargain sales.

One very common example of a bargain sale to a charitable organization is the sale of real estate to a charity. In many cases, the property transferred is exchanged for other similar property of lesser value, and the difference is considered a gift.

What is an installment bargain sale?

The basic concept of a bargain sale is straightforward. The owner of an asset, typically real estate, sells it to a charity for less than the property’s appraised fair market value. The charity pays the donor the sales price in a single lump sum at the time of the transaction and the donor gets a charitable deduction for the difference between the value of the property on the date of gift and the sales price. If the property is appreciated, the donor must pay tax on the gain attributable to the sales price.

An installment bargain sale is a variation on this concept, where the charity pays off the donor in a series of payments rather than in a single lump sum. With an installment bargain sale, the donor receives a charitable deduction for the difference between the value of the property and the present value of the payments to the donor. In effect, the donor is making a loan to the charity during the installment period, so the payments are treated partly as interest, partly as capital gain income, and partly as tax-free return of principal. Sounds a little bit like a gift annuity, doesn’t it?

The amount and timing of the installment payments are negotiated between the donor and the charity. Typically the payments are all the same amount and made annually, but this is not required. The first payment can be larger than the rest, like a down payment on a house, or conversely, the installments can end in a balloon payment that is larger than all that came before. Payments also can be deferred until a few years after the gift. Whatever schedule of payments is agreeable to both parties can be followed. No gift annuity or charitable remainder trust offers that kind of flexibility.

When might an installment bargain sale be of interest?

A bargain sale is most commonly used to facilitate a gift of real estate that the charity wants to keep. The arrangement enables the owner to collect an amount of sales proceeds with which the owner is comfortable and make a gift of the rest, thereby earning some tax benefits. At the same time, the charity is able to acquire a parcel it wants to keep for less than market price.

Even at a bargain price, however, the receiving organization may not have the wherewithal to make the payment comfortably in one lump sum. By making its payments in installments, the charity can spread the cost over several fiscal years, easing its cash flow burden in the process.

There are also instances where the donor drives the desire for payments to be made in installments rather than the charity. For example, the donor may want to spread any reportable capital gain over several years. Or the donor may view the sale as a way to create a fixed term annuity that will provide a few years of steady income before he or she starts taking funds from other sources, such as an IRA or other retirement account.

Mortgaged Property:

In general, if an appreciated asset is given to a charitable organization, the donor does not realize the appreciation as a capital gain for federal income tax purposes. The reason is that gain is generally realized only if an appreciated asset is sold or exchanged; a charitable contribution is merely a donative disposition.

If appreciated property subject to a mortgage is given to charity, however, the transaction is treated as a bargain sale under Reg. section 1.1011-2, and the donor does realize a portion of the appreciation as a capital gain.

Bargain sale formula: The amount of gain (G) realized when mortgaged property is given outright to a charitable organization can be determined using this formula:

G = (FMV - B) x (M/FMV), where:

“FMV” is the fair market value of the donated property.
“B” is the property’s adjusted basis in the donor’s hands.
“M” is the amount of the mortgage debt. See Reg. section 1.1011-2(b).

For example, if property worth $100,000, having a $40,000 adjusted basis in the donor’s hands and subject to a $20,000 mortgage, is given outright to a charitable organization, the donor realizes a gain of ($100,000 - $40,000) x ($20,000/$100,000), or $12,000.

The donor is also entitled to claim a charitable deduction of $80,000 — his or her equity in the donated property.

Note that in the case of property that has been subject to accelerated depreciation, a portion of the gain realized by the donor may be ordinary income — representing recapture of depreciation claimed in excess of straight line.

Substantiating Gift Value

A qualified appraisal — as that term is defined in Reg. section 1.170A-13(c) — is generally needed to sustain a claim of an income tax charitable deduction with respect to a donation of real estate if the claimed value of the property (or the aggregate claimed value of all real estate gifts made during the year) exceeds $5,000.

In addition to obtaining a qualified appraisal, the donor is required to file an appraisal summary — IRS Form 8283 — with the federal income tax return on which the gift is first claimed or reported. See Reg. section 1.170A-13(c)(2). The appraisal summary must be acknowledged (signed) by the donee organization. In the case of noncash contributions valued at more than $500,000, a copy of the qualified appraisal must be attached to the return.

If the donee organization, within three years of the date of gift, sells or otherwise disposes of donated property for which it has signed a IRS Form 8283, it must report the sale to both the IRS and the donor on IRS Form 8282. See Reg. section 1.170A-13(c)(4)(iii).

Requirements for a qualified appraisal: Full details of the requirements an appraisal must meet to be a qualified appraisal are beyond the scope of this discussion. Nonetheless, it is worth noting some of the items of information that, by definition, must be included in a qualified appraisal:

The date or expected date of gift.
The appraised fair market value on the date or expected date of gift.
The appraiser’s tax ID number.
A statement that the appraisal was prepared for federal income tax purposes.
A description of the appraiser’s background, education, experience, and membership (if any) in professional appraisal associations.
A description of the fee arrangement between the donor and the appraiser. See Reg. section 1.170A-13(c)(3)(ii).

In order for an appraisal to be a qualified appraisal, it must be obtained no earlier than 60 days before the date of gift and no later than the day before the due date of the income tax return on which the gift is first claimed or reported. Due date includes extensions of time to file the return. See Reg. section 1.170A-13(c)(3)(i)(A).

Substantiation rules: Special receipts are now required for gifts of cash or property valued at $250 or more. This requirement does not affect the qualified appraisal rules described above. Donors should keep all receipts and letters of acknowledgment in order to substantiate their deductions. See IRS publication number 526 and 1771.