John owns a rental home valued at $1 million that he bought for $200,000 many years ago. John's income tax rate is 37% and his capital gains tax rate is 23.8%. He asks his financial advisor what the tax benefits would be if he gifted the rental home outright to a charity. His financial advisor informs him the capital gains will be bypassed and he will receive an income tax deduction equal to the value determined by a qualified appraisal of the property.In general, for a charitable gift of real estate that has been held for longer than one-year, the charitable deduction will be the fair market value as determined by a qualified appraiser. If the property has been held for less than one-year or the property is an inventory-type asset, the donor's deduction will be limited to the lesser of cost basis or fair market value. In practice, the lesser of these two is most often the cost basis.
If John were to sell the rental home at its FMV, he would realize $800,000 in capital gains. At his 23.8% tax rate, he would owe $190,400 in capital gains tax. By contributing the rental home outright to charity rather than selling and donating the cash proceeds, John bypasses $190,400 in capital gains tax. John also will receive an income tax deduction of $1 million. At his 37% income tax rate, the charitable contribution will generate an income tax savings of $370,000. John is pleased with the combined tax savings of $560,400 and moves forward with donating his rental home to his favorite charity.
Martha owns real estate valued at $1 million that she purchased for $500,000 over a year ago. Her income tax rate is 32% and her capital gains tax rate is 18.8%. She would like to sell her home and make a gift to a charity, but would like to minimize any income and capital gains tax related to the sale. Martha's tax advisor informs her that if the portion contributed to charity is properly apportioned, the income tax deduction can offset her capital gains tax. The tax advisor recommends Martha follow his plan set below to generate a zero-tax sale.Despite the benefits for donors, as with all gifts of real estate, charities must be aware of the risks associated with accepting real property outright. The charity is added to the chain of title which can raise environmental risk liability under CERCLA. Charities must ensure the risks are outweighed by the financial benefits.
Prior to the sale, Martha donates 22.71% or $227,060 of the property to charity. The remaining $772,940 is retained and sold. The property is then listed for sale jointly by the charity and Martha and transferred to a third-party buyer. The outright contribution valued at $227,060 results in an income tax deduction, creating a tax savings of $72,659 based on Martha's 32% income tax bracket. The capital gains bypass on the charity's portion will save $21,344 based on Martha's 18.8% capital gains rate. The sale of the retained portion of the property valued at $772,940 results in a taxable gain of $386,470. Martha's 18.8% capital gains tax rate generates $72,656 in capital gain taxes. However, the tax on the gain is offset by the income tax savings of $72,659, leaving a net benefit to Martha of $3.
Therefore, the net to Martha is the $772,940 cash from the sale, minus the tax on the gain of $72,656, offset by the $72,659 from the tax savings, for a total of $772,943. Compared with the sale of the entire asset, Martha reduces her taxes and makes a gift of $227,060. The advisor explains that the $227,060 charitable deduction may only be taken up to 30% of her AGI for the year, but any unused charitable deduction can be carried forward for an additional five years. She may not realize a zero-tax sale in the year of the sale, but it likely will be realized within six years.
Alex owns property that he has agreed to sell to a charity. He purchased the property two years ago for $50,000 and it was recently appraised at $250,000. Alex is in the 32% income tax bracket and the 18.8% capital gains tax bracket. The charity has agreed to purchase the property for $100,000. Alex asks his financial advisor how the sale will be taxed. The advisor informs Alex that this is a bargain sale. The charitable deduction is the difference between the FMV and the sale price. Thus, Alex will have an income tax deduction of $150,000. At the 32% bracket, Alex will save $48,000 in income tax.
However, the advisor informs Alex that capital gains will be due on the sale portion of the transfer. Alex has a gain of $80,000 based on the allocated basis amount of $20,000 and the $100,000 purchase price. At Alex's 18.8% capital gains rate, he will owe $15,040. The income tax savings of $48,000 will offset the capital gains tax owed of $15,040, resulting in a net benefit of $32,960. In total, Alex receives $100,000 from the sale, donates $150,000 to the charity and has a net tax savings of $32,960.
Eric is a longtime supporter of his favorite charity. He owns land near the charity's main office that the charity is interested in purchasing from Eric to expand its operations. The land is valued at $1.6 million, Eric is interested in receiving cash out from the property. The land was purchased years ago at a value of $400,000. When Eric heard of his favorite charity's plans to expand its footprint, Eric reached out in the hopes he may be of help. He intended to make a major gift to charity of $1 million in support of his favorite charity's mission. Eric and the charity agreed to enter into a bargain sale for the land for $600,000. Charity's board requested the option of a bargain sale with a 10-year installment note. This structure was beneficial to Eric because his capital gain realization will occur over the course of the term of the note.
Eric receives an income tax deduction of $1 million, which is the difference between the fair market value of the land and the purchase price. Based on his allocated basis of $150,000, Eric has capital gains of $450,000 over the 10-year term on the sale portion of $600,000. Under the 10-year installment note, the charity will make annual payments of $60,000 plus interest over the term of the note. The structure of the installment bargain sale allows the charity to begin expansion on the newly acquired property. In total, Eric satisfied his desire to donate $1 million, received a partial bypass of capital gain and transferred his land to charity.