Charitable Benefits from Bargain SalesSubmitted by American Endowment Foundation on January 28th, 2019
By Eric Kinaitis
For many, real estate is the largest asset they own. In fact, real estate is the largest asset class in America, comprising an estimated 43% of America’s total wealth. Yet, less than 3% of total charitable giving comes from gifts of real estate.
So why is the largest asset class in America ignored when it comes to the concept of charitable giving? The likely answer lies both in awareness and complexity.
Most donors are driven by the belief in the cause they want to support and focus less on the process involved in how that support is given. The concept of sending a check (or giving a credit card number) is the route of easiest giving, if not necessarily the most effective for the financial wellbeing of the donor.
For financial advisors, their knowledge of their clients’ real estate holdings may be very limited. Managing the health of their clients’ investable assets of stocks, mutual funds, etc. takes precedence over the illiquid (and uncompensated) value of their real estate.
The average residential real estate gift is $550,000 and the average commercial gift is $900,000. According to Bruce Geiss, COO of Realty Gift Fund, a special nonprofit exclusively devoted to accepting real estate gifts for the nonprofit world, “Real estate represents the largest opportunity for the nonprofit world in the coming decade as the baby boomer wealth transfer peaks.”
Most major giving is driven by charitable intent, a shared belief in a nonprofit’s cause, but should always be supported by intelligent tax strategies. For wealthy clients, cash has been the route of easiest giving but is often the least efficient in a smart estate plan that targets the donor’s hard and soft goals. Of course, a gift of an appreciated asset avoids capital gain taxes and receives tax benefits based on current value. However, the gift of a complex asset also simplifies an estate, reduces the burden on heirs (who avoid the sudden responsibility for management, maintenance, financial needs, and liquidation), and can create a family legacy.
“Typically, real estate is a gift of considerable value, is often encumbered with debt, and is subject to closing and holding costs not common with other charitable gifts,” said Geiss. “Traditional nonprofits rightfully avoid real estate for lack of experience and the needed cash resources. The breakdown starts with the nonprofits and has contributed to a silence among the two other key legs of the philanthropy stool…donors and advisors.”
”Real estate donations often need some level of cash payment from the nonprofit to the donor”, Geiss goes on to say. This is where the bargain sale comes into play.
Implemented by the IRS back in 1917, the bargain sale is a donation of any asset that consists of a partial cash payment for less than its Fair Market Value (FMV). The donation value is the difference between the FMV and the partial cash payment. In a bargain sale, a real estate owner is both a seller (for the cash portion) and a donor (for the donated portion). The cash portion is taxed at a reduced prorated level, but the charitable portion avoids all capital gain taxes.
To restate, a bargain sale consists of three parts:
- A qualified appraisal to establish the property’s Fair Market Value
- A partial cash payment for less than the Fair Market Value
- A charitable contribution for the difference
The charitable portion of the bargain sale provides the donor an immediate federal tax deduction equal to the donated portion, up to 30% of the Adjusted Gross Income (AGI) in the year of the donation. If the charitable portion is greater than 30% of the donor’s AGI in that first year, the excess can be carried forward for five additional tax years.
The amount of the cash payment is negotiated, and can be requested by the donor for any use. It is commonly used to:
- pay off debt
- fund donor’s closing costs
- return initial invested capital
- reduce the size of the donated portion to optimize tax benefits
- pay for replacement life insurance for heirs
- fund gifts or trusts for children
- fund other investments
- any other personal use
Let’s look at a real-life example to further illustrate the strength of a bargain sale.
LOCATION: Albuquerque, NM
PROPERTY: 19,000 Sq. Ft. Retail Building on 46,000 Sq. Ft. of Land
An investor owned a property for more than 30 years. Due to continued depreciation and increases in the property’s value, the investor was facing a significant capital gains tax upon sale of the property.
During most of this 30-year period the property was fully occupied. However, the property went vacant for five years and the investor attempted to sell it for $1,100,000. While vacant, the investor was obligated to cover payments on a first mortgage of $350,000, plus payments for property taxes, insurance, maintenance and utilities.
After an extended two year selling period, no buyers were identified at the seller’s expected price.
Realty Gift Fund (RGF) entered a negotiation with the seller for a bargain sale. The seller obtained a “qualified appraisal” of $900,000. RGF agreed to pay $350,000 in cash and to accept a charitable donation for $550,000. The cash payment was used to retire the seller’s first mortgage enabling the property to be conveyed to RGF on a free and clear basis.
RGF listed the property for $900,000. A buyer was located who desired to open a restaurant, and who planned to demolish the existing improvements which subjected the existing land plan to new regulatory requirements. A price was negotiated to accommodate the buyer’s new plan, and the sale provided RGF net proceeds as a major gift.
Through the bargain sale, the donor fulfilled his charitable intent, received a $550,000 charitable deduction, and eliminated the burden of holding onto an outdated vacant property.
Through this process, the donor can direct most of the net proceeds of the ultimate sale to a donor advised fund (DAF), allowing the donor to recommend grants to qualified nonprofit organizations on the donor’s own timetable.
Through American Endowment Foundation, the donor’s financial advisor can remain involved in managing the investment dollars that reside in the DAF account, thereby turning a previously unmanageable asset into new AUM for the advisor.
At AEF, let us help you in deciding if a bargain sale can be a means in turning an illiquid asset into charitable goodwill. Contact us or call at 1-888-966-8170.