Federal and State Income Tax Benefits are only available to Sellers with enough taxable income to fund the charitable contribution associated with the transaction. When the Seller calculates their Adjusted Gross Income (AGI) for tax purposes, they can claim up to a 60% deduction if the money was used for charitable purposes.
In many cases, this valuation usually falls between the value amount of the bank’s appraisal and the insurance company’s appraisal. But, again, it depends on the type of real estate and where it is located.
The exact tax deduction you would receive depends on your current tax liabilities. A tax professional can assist you further with this.
What Does It Mean to Have an IRS Section 170 Bargain Sale?
An IRS Section 170 Bargain Sale (aka. Bargain Sale) is when a non-profit organization (Buyer) pays cash for a real estate property at a Bargain Sale. The Seller receives the cash and a generous tax rebate or tax reduction on their Federal Income Tax and State Income Tax Returns.
The IRS allows the cash amount to be between five and seven figures. Depending on their tax liability, the Seller can enjoy all the tax benefits in as little as 30 days. But even if it takes longer, the Seller is given as many as six years to use the entire deduction amount.
In 1917, the IRS Section 170 Bargain Sale law was implemented into federal legislation called the War Revenue Act, which was before the 1031 Exchange ever existed. The primary purpose of this tax law was to promote philanthropy in the country. The tax law turned out to be a success because numerous philanthropists got involved in charitable real estate transactions.
According to statistics, more than 20,000 real estate transactions take place each year that utilize the IRS Section 170 Bargain Sale. The estimated value of all these transactions is equal to around $8 billion. IRS Code Section 170 regulates all real estate transactions involving charitable contributions and non-cash transactions. If you want to learn more about these tax guidelines, look up IRS Publication 526 and IRS Publication 561 for more information.
A Bargain Sale real estate transaction has a lot of similarities to a traditional real estate transaction. The primary difference is the Buyer is tax-exempt, while the Seller is entitled to a tax deduction on a percentage of the proceeds from the transaction. However, the rest of the process works the same for the Buyer and Seller.
For example, a real estate agent is typically present to manage the transaction for the Buyer and Seller. The agent will handle the paperwork and work with the title company to arrange a closing date for the transaction. But since it is a Bargain Sale, the tax guidelines under IRS Section 170 will apply to the transaction. These are guidelines not generally found in other transactions, such as:
How is the Property Value Calculated?
Salute Veterans Inc. does not conduct appraisals or valuations on properties. A certified appraiser from an independent third-party company must perform the appraisal for fairness purposes. MAI-designated appraisers are the best in the business, in our opinion. But as long as you choose appraisers who have their official credentials in order, it is all that matters.
The appraisers you choose must have knowledge of IRS Section 170 because it explains the tax guidelines surrounding the valuations of real estate in a Bargain Sale. You can also find more information about the general tax and appraisal guidelines of Bargain Sales in IRS Publication 561.
The real estate appraisal methods used for Bargain Sale properties are different from standard real estate appraisal methods. IRS Publication 561 establishes specific guidelines on how an appraiser must acquire the property’s Fair Market Value in the transaction.
According to the IRS, the Fair Market Value reflects the price agreement between a Seller and Buyer who want to close a deal. It is assumed that the Buyer and Seller have done their due diligence and understand the relevant facts about the transaction and the property.
The appraiser determines the length of time needed for the Seller to market and dispose of their asset. The contributing factors of this decision include the location, size and type of property involved. There are cases where it can take more than three years for Sellers to liquidate their properties. That is how long it can take for Sellers to find the right non-profit Buyers to purchase these properties. But since you’ve already found Salute Veterans, it won’t take that long.
The IRS treats real estate properties as non-fungible assets. What this means is that no two real estate properties are 100% the same. The unique characteristics of each property have a greater influence on the value than the values of comparable properties.
When a buyer applies for a home loan at a bank, it is common practice for the bank to determine a lower value for the property because they’ll want to limit their liability. But if it’s an insurance-based appraisal, the valuation will likely be higher because they have to consider the potential replacement costs involved.
On the other hand, an IRS Section 170 Bargain Sale uses five specific guidelines to generate the Fair Market Value. These guidelines include:
Does Market Demand Affect the Fair Market Value?
The law of supply and demand has the most significant influence on a property’s Fair Market Value. When there is greater demand in the real estate marketplace, it drives the valuation amount higher. High demand is ideal for property resellers because they don’t have to spend as much time on mundane marketing tasks to seek out demand. Instead, the demand comes to them.
The problem is that a property reseller in this situation doesn’t promote the Fair Market Value of their property. According to IRS valuation rules, the Seller must have a reasonable marketing budget to convey the Fair Market Value to potential buyers because that is how demand is generated. When there is more demand, it creates a higher valuation for the property.
So, one can determine that a longer time spent on marketing a property will increase its Fair Market Value.
What is the “Highest and Best Use?”
The “Highest and Best Use” concept is what a property appraiser will use to help determine the Fair Market Value of a property. Basically, the appraiser considers the best possible way in which the property can be used to achieve maximum productivity and value.
For example, let’s say an old factory building is being considered for a Bargain Sale. The appraiser may value the building as a commercial office building with several different offices in it. Either that or they could value it as a condominium complex with several livable units inside. That way, the appraiser can generate the highest valuation possible for the building.
How is the Comparable Sales Method Used?
Bank appraisals will typically use the comparable sales method to calculate the values of properties. This method makes a comparison between the property in question and several other comparable properties with similar features and attributes. Banks usually prefer recent comparables of similar properties sold within the past six months.
Of course, a unique property probably won’t have any recent comparables available. For instance, a huge industrial complex or factory building will likely have no comparables in the area, at least none sold within the past six months. So, the appraiser might have to search farther than six months into the past to find the best comparables. It may even require them to explore geographical areas that are farther away from the subject property. That way, they can calculate the most accurate valuation possible for it.
How Does an Incoming Producing Property Affect the Fair Market Value?
When a real estate property already generates a net income, a capitalization of income appraisal method will be implemented to determine the property’s value. The appraisal considers the present return on investment and potential investment risks in order to calculate the value. A higher value is usually generated from this method because it combines the physical property value and its net income value are both used to determine the overall Fair Market Value. Comparable factors like local rental rates and available inventory are also used to calculate the value.
How Do Replacement Costs and Depreciation Affect the Fair Market Value?
The appraiser considers various elements concerning the total replacement cost of the property, such as the expenses associated with labor, materials, overhead, building size, workmanship quality, and potential profit. If it is a historic property, the appraiser may consider reproduction costs rather than replacement costs, which will certainly drive up its valuation. After all, the present condition and longevity of a property have a big impact on the valuation. A reproduced property will obviously have a longer life, so it will have a higher valuation.
What is the Difference Between the IRS Section 170 Bargain Sale and a Donation?
The IRS Section 170 Bargain Sale involves a combination of a buyer’s cash payment at the closing of the sale and special tax savings that comes in the form of a cash rebate or tax reduction. A regular donation of property does not involve any cash payment whatsoever, nor is there any consideration of the property’s Fair Market Value. The Seller won’t be motivated to research tax deductions or IRS guidelines if they donate the property without receiving cash.
However, it is in the best interests of the Seller to execute an IRS Section 170 BargainSale. Not only will the Seller receive a cash payment at the closing of the transaction, but they may also clear out the debts owed on it too. In addition, the Seller can release themselves from numerous tax liabilities after receiving a generous tax deduction from the deal.
Which Party is Responsible for Paying the Appraiser?
Most tax authorities require the Seller to pay money out of pocket for an appraiser during a Bargain Sale transaction. It is technically not a legal guideline because the tax code does not specify which party pays for the appraiser. But in most of these transactions, there is an expectation that the Seller will cover the appraisal costs. Otherwise, the Buyer would see it as a conflict of interest.
Does the Buyer Need a Charitable Use for the Property? How Does it Affect the Seller?
When a non-profit organization purchases property as a Buyer, they don’t necessarily need a charitable use for the property. However, their specific purpose for buying the property will affect the tax deduction in which the Seller receives. If you look up the IRS’ rules regarding “Related Use,” they explain more about what the Seller is entitled to claim as a charitable contribution from the Bargain Sale.
For example, let’s say a Seller paid $5,000 for a piece of fine art approximately five years ago. Now the artwork has been appraised for $10,000. The Seller wishes to donate the artwork to a non-profit organization and claim a $10,000 deduction based on its present appraisal value. Unfortunately, the Seller finds out the non-profit organization (Buyer) will not use the artwork for any charitable purpose or cause. That means the Seller cannot claim a $10,000 deduction. Instead, the IRS only allows the Seller to claim the original price they paid for the artwork as a deduction, which is $5,000 in this case.
If you’ll notice, we used a piece of tangible personal property as an example of the asset. IRS Publication 526 describes separate “Related Use” guidelines for tangible personal property and real estate property. Tangible property is any property that can be physically touched, such as books, cars, and paintings. Land and buildings are excluded under this classification. The IRS puts land and buildings under the real estate classification, described as capital gain property in which the Seller holds for over one year. In other words, if the Seller sells property at Fair Market Value as a charitable contribution and a long-term capital gain is recognized, then it is a capital gain property.
There are different factors involved in calculating the tax deductions from capital gain property contributions. Mainly, you have to focus on the long-term capital gain that would have been realized if the property was sold at Fair Market Value. This long-term capital gain amount gets subtracted from the Fair Market Value to determine the tax deduction amount. That amount reflects the Seller’s cost-basis or their total investment in the property.
What is the Benefit of Donating Property to Salute Veterans?
We’ll give you three good reasons to donate your property to Salute Veterans.
1) The Seller receives a tax deduction equal to the appraised value of the property. The IRS allows the Seller to carry this deduction forward for a period of five tax years.
2) A real estate donation significantly reduces the Seller’s tax liabilities and other legal liabilities. If the property was sold on the traditional real estate market, the Seller could not take advantage of these benefits.
For example, as the Seller, you won’t have to pay additional income taxes, property taxes, maintenance expenses, and repair expenses if you donate your property to Salute Veterans. You also won’t have to worry about paying legal fees, brokerage fees, realtor commissions, estate taxes, inheritance taxes, capital gains taxes, or any other taxes or costs associated with the transaction.
Many Sellers find that real estate donations benefit them more financially.
3) How would you like to support the veteran community? Salute Veterans is a non-profit organization dedicated to helping the veteran community through the charitable contributions it receives. You can feel good about yourself knowing that your real estate contribution will be used to serve our country’s veterans.
Does the Seller Pay Taxes on the Cash Portion of a Bargain Sale?
Yes, the Seller does have to pay taxes on the cash received in an IRS Section 170 Bargain Sale. IRS Publication 544 features a unique formula used to calculate the taxes. It is a pretty straightforward calculation that does not require advanced mathematical knowledge.
The formula is as follows:
Cash Portion – (Adjusted Cost Basis * (Cash Portion / Fair Market Value)) * Applicable Tax Rate
First, divide the cash portion of the sale by the property’s Fair Market Value. Then, take that answer and multiple it by the Adjusted Basis. Now take that number and subtract it from the total cash portion of the sale. Finally, whatever number is left from that, multiply it by the applicable tax rate.
For instance, suppose you paid $400,000 for a commercial building five years ago. Now the Fair Market Value of the building is $800,000. However, the depreciation on the property has made the adjusted cost basis approximately $300,000. So, you’ve decided to donate the property to a charitable organization like Salute Veterans. You receive $100,000 for the cash portion of the Bargain Sale.
Let’s plug the numbers into the formula:
$100,000 – ($300,000 * ($100,000 / $800,000) = $62,500 * 20% Capital Gains Tax Rate = $12,500 tax
In this example, you would have owed $12,500 in taxes.
Will I Always Be Entitled to Tax Savings If I Donate My Property?
Yes, the tax provisions of the Federal Government and various State Governments offer generous tax benefits to Sellers who donate their properties. In fact, a Seller can receive up to a 39.6% deduction on their federal income tax liability and a 12% deduction on their state income tax liability. If you live in a state with no state income tax, you already enjoy the benefit of not having to pay state income taxes.
Is a 1031 Exchange Different Than a Bargain Sale?
Yes, there is a difference between the two. The 1031 Exchange lets you defer taxes, while the IRS Section 170 Bargain Sale enables you to reduce taxes. Each one offers unique benefits.
A 1031 Exchange lets you accumulate wealth without having to pay taxes. You only pay taxes when you cash out your account and withdraw the money you earned. The tax rate is applied to the total amount of the profits you accumulated.
A Bargain Sale gives cash to the Seller at the closing of the real estate transaction. The Seller can also enjoy generous tax deductions to reduce their income tax liability significantly.
Sellers prefer Bargain Sales because they can eliminate or significantly reduce their tax burden rather than merely delay it. If you choose the 1031 Exchange option, you will eventually have to pay a higher tax rate when you cash out your account.
So, why not get rid of your tax burden immediately with a Bargain Sale? It makes more sense.
Can a Bargain Sale Help Me Avoid Taxes If I Cash Out of a 1031 Exchange?
That is probably a question better answered by a tax professional because it would depend on your current tax liability. You can definitely expect a large tax bill to be owed when you cash out your account.
It is possible to reduce or eliminate your tax liability from the 1031 Exchange if you conduct an IRS Section 170 Bargain Sale. The charitable portion of the sale could significantly reduce your tax liability from the exchange.
Here is how that process would work:
Disclaimer:
Salute Veterans is a non-profit organization that accepts real estate donations to help veterans. Our organization is not offering any professional legal, investment, financial or tax advice whatsoever. The information we’ve provided is unverified and only provided in good faith. All parties are responsible for doing their own research and due diligence regarding legal, investment, financial, and tax-related topics.
