Bargain Sale Rules for Churches
Donations to the local church and other ministries come in several forms including the donation of real estate, but what happens if the donated property has an existing mortgage on it? Could Bargain Sale rules apply? Certainly any donation that financially benefits the ministry is a blessing, but this type of donation can be complex. I want to try to unpack this issue for you and explain it in the simplest terms possible.
I was recently engaged by a church to assist this this sort of transaction and the church wanted to know the best way to handle the donation and what charitable donation could be available to the donor. In this particular case; the donor did not occupy the residential property as a primary residence so a §121 election (Exclusion of gain from sale of principal residence) was not possible and “gains” would need to be considered capital gains rather than ordinary income.
Due to these factors and the existence of an existing mortgage on the residential property; “Bargain Sale” rules would apply which means that a portion of the transaction is actually a sale from the donor to the church and the remaining portion of the transaction is a charitable donation. Typically; the “sale” component of the transaction is equal to the amount of the existing mortgage, but how much is the “charitable contribution”?
Let’s assume the residential property has a fair market value of $200,000 with a basis of $150,000 and existing mortgage of $100,000. At first glance; one would assume that the “sale” amount is $100,000 so the donor would be able to write off $100,000 (FMV minus sale/mortgage) as a “charitable contribution”. Unfortunately; this would not be the case under “Bargain Sale” rules since the difference between the FMV and the sale amount is pro-rated between “charitable contribution” and the “sale”. The formulas can be a bit confusing, but in short the donor would realize a $25,000 capital gains and $75,000 charitable contribution ($50,000 net charitable contribution). The exact formulas can be found in IRS Publications 526 (charitable contribution) & 544 (sale/gain).
This transaction also requires a formal appraisal of the subject property and for the appraiser to verify the appraisal on IRS Form 8283 which needs to be filed by the donor with his/her annual tax return for the year that the deduction was claimed. Additionally; the donee (ministry) must file IRS Form 8282 within 125 days after the disposition (sale, transfer, etc.) of the donated property.
As you can see from the illustration above; this type of transaction can be complex from a tax perspective for both the donor and donee. I recommend consulting with a tax professional before accepting or making this sort of donation to ensure that the maximum financial benefit is realized by both the ministry and donor.
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