9069 / How is the charitable contribution deduction computed when property is sold to a charity at a reduced price (in a “bargain sale”)?

To determine the permissibility and the amount of the deduction for the contributed portion, the value of the contributed portion must be reduced by any gain that would not have been realized as long-term capital gain had the contributed portion been sold, taking into account the basis allocated to it.² If the sale of the contributed portion by the donor would have resulted in long-term capital gain (see example 2, below), no reduction is required unless the gift is tangible personal property and the use of the gift will be unrelated to the function of the charity.³

After any such reduction required by IRC Section 170(e)(1) has been made, the remaining amount of the contribution is the allowable deduction.

The taxpayer’s adjusted basis in the property is then allocated to each portion in these proportions.⁴ It is allocated between the portions contributed and sold, based on their relative proportions of the property’s fair market value.⁵ Gain is recognized on the sale portion to the extent the amount realized exceeds the allocated basis. However, no loss is recognized if the sale amount is less than the allocated basis of the sold portion.⁶ The amount of the deduction for the contributed portion is determined as if property having the allocated basis and allocated fair market value were given.

The end result of this analysis is that essentially two separate transactions take place: (1) a sale of property that may result in taxable income, and (2) a deductible contribution of property to the charity. In some cases, the application of these rules may result in a taxable gain in excess of the allowed deduction. If the property is subject to a liability, the amount of the liability is treated as an amount realized.⁷

Example 1. Dale sells ordinary income property to his church for $4,000, which is the amount of his adjusted basis. The property has a fair market value of $10,000. The contribution portion of the transaction has a value of $6,000 ($10,000 fair market value less $4,000 amount realized) that represents 60 percent of the value of the property. The amount realized represents 40 percent of the value of the property ($4,000/$10,000). The adjusted basis ($4,000) is therefore allocated as follows: 40 percent of it ($1,600) becomes Dale’s basis in the “sold” portion and 60 percent of it ($2,400) becomes his basis in the “contributed” portion. The $6,000 “contribution portion” of the transaction has an allocated basis of $2,400. If it were sold, he would recognize $3,600 of ordinary income. The deduction for the $6,000 contribution is therefore reduced by $3,600. Dale has a charitable deduction of $2,400. Because Dale is receiving $4,000 for the “sold” portion and has an allocated basis in it of $1,600, he recognizes $2,400 of ordinary income with respect to the sale part of the transaction. The church’s basis in the property received will be $6,400; this consists of the sum of the bargain sale price ($4,000) and the amount of Dale’s basis ($2,400) in the gift portion.⁸

Example 2. The facts are the same as in Example 1, except that the property was long-term capital gain stock. Dale’s allocations of basis are the same as above; therefore, he recognizes $2,400 on the sale portion of the transaction. However the contributed portion is not subject to a reduction; thus, he is permitted a deduction of $6,000. The church’s basis in the stock will be $6,400, determined the same way as in Example 1.

A taxpayer who makes charitable contributions of long-term capital gain property may elect to apply the provisions of IRC Section 170(e)(1) to all such contributions, thus using adjusted basis instead of fair market value to determine the value of the gifts. This election permits the individual to take a higher proportion of income as charitable deductions than would otherwise be allowed (see Q 9065).

In the context of a bargain sale, the Tax Court has found that the charitable deduction was properly claimed in the year that the sale was completed, because sufficient benefits and burdens of ownership had passed to the charitable organization in that year.⁹ Bargain sale treatment was denied to a taxpayer who inflated his valuation to a figure that would enable him to recover his original investment in his property (in the form of cash plus tax savings from the inflated tax deduction).¹⁰