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Max out your charity donation with a ‘bargain sale’

by on
in Small Business Tax,Small Business Tax Deduction Strategies

If you've been thinking about donating your used car to charity, don't drop the idea just because of last year's law that put the squeeze on big-ticket donations. That law curbed your potential to be aggressive in placing a high value on the donated item. But by taking a different route, you can still get your money's worth.

Strategy: Arrange a "bargain sale" of the item to a qualified charity. Unlike a straight charitable donation, you'll earn cash back from the charity, plus a sizable deduction based on the item's fair market value.

The charity wins, too. It gains an asset that it can use for its own purposes or resell at a reasonable price. A number of groups actively pursue bargain sales of boats and cars on a regular basis (see box at right).

How it works: When you sell assets, such as cars or boats, to a qualified charity at a bargain price, you treat part of the transaction as a sale and the other part as a charitable donation. The part that's considered a donation is the difference between the asset's fair market value and the bargain-sale price. The other part may result in a taxable gain if you have a low basis in the donated asset.

To determine the amount of your taxable gain, adjust your basis to take into account both parts of the transaction. The formula for figuring out the adjusted basis is (1) the adjusted basis of the entire asset multiplied by (2) the amount realized divided by the fair market value of the entire asset.

If you plan out things correctly, the tax deduction for the charitable element of the bargain sale can offset the taxable gain on the sale portion, with plenty to spare.

Example 1: Sale of appreciated asset

Let's say you bought a classic collector's boat several years ago for $30,000. It's now worth $40,000. If you sell the boat to charity for the original $30,000 cost, your adjusted basis for the taxable portion of the bargain sale is $22,500 (75 percent of $30,000). So, you recognize a taxable gain of $7,500 ($30,000 sale proceeds minus $22,500 basis).

Since the gain qualifies as long-term capital gain taxed at the 15 percent maximum federal rate, you will owe Uncle Sam $1,125 in tax (15 percent of $7,500).

You're also entitled to a charitable deduction for the extra $10,000 attributable to the value of the boat, assuming the charity will use the boat in its tax-exempt purpose. If not, the IRS limits your deduction to the $7,500 basis. For example, if
the charity sells the boat, your deduction is limited to $7,500.

In your 33 percent tax bracket, the deduction is worth $3,300 to you, almost three times the taxable amount on the gain. Plus, you walk away with $30,000 in cash.

Example 2: Sale of depreciated property

The bargain sale strategy can also work for property that has declined in value.

For example, say you bought a car for $30,000 that's now worth $20,000. Let's say you agree to sell the car to a charity for $15,000. In this case, you receive $15,000 in cash from the charity and claim a $5,000 charitable tax deduction on your return. You pay zero tax on the sale, since the car is worth less now than when you bought it.

Since a bargain sale involves a valuation, you still have to contend with the new substantiation requirements (see box below). But you have less at stake here than with a straight donation. Reason: The key to the deal is the bargain price arranged with the charity; that's the amount of cash you'll be getting back in the deal.

Online resources:

Bargain sales of boats

• American Institute of Marine Studies, www.aimsamerica.org/boat-donations.htm

• Marine-Network.com, www.projectboatco.com/projectboats/projectboats_ 10.html

• Oxfam, www.oxfamamerica.org/whatyoucando/donate/create_legacy/options/art2689.html

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