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Navigate tricky tax waters for boat, car sales to charity

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in Small Business Tax,Small Business Tax Deduction Strategies

Are you thinking of donating a boat or a car to charity? Maybe you can’t afford to simply give it away.

Strategy: Arrange a “bargain sale.” Unlike a regular charitable donation, you get cash back from the charity plus a write-off based on the difference between the bargain sale price and the property’s fair market value.

Will the charity agree to the deal? Many tax-exempt organizations will buy vehicles while others specialize in bargain sales of boats (see box).

Here’s the whole story: If you sell assets such as cars and boats to  charity at a bargain price, you must 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 price. The other part may result in a taxable gain if your basis is low.

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

By planning ahead, you can use the tax deduction for the charitable part of the sale to offset the taxable gain on the sale portion—with plenty to spare.

Example 1: Bargain sale of appreciated property

Let’s say you bought a boat several years ago for $30,000 that’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% times $30,000). Thus, you realize a taxable gain of $7,500. Because the gain qualifies as long-term capital gain taxed at the 15% rate, you will owe Uncle Sam $1,125 in tax (15% of $7,500).

However, you’re also entitled to a charitable deduction for the extra $10,000 attributable to the value of the boat, assuming the charity uses it to further its tax-exempt purpose. In your 33% tax bracket, the deduction is worth $3,300 to you—almost three times the tax on the gain. Plus, you walk away with $30,000 in cash.

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

Example 2: Bargain sale of depreciated property

Suppose you bought a car for $30,000 that’s now worth $20,000. You agree to sell the car to a charity for $15,000. In this case, you’ll 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 because the car is worth less now than when you bought it.

Since a bargain sale involves a valuation, you must contend with strict substantiation requirements now imposed by the IRS. But you have less at stake here than you would with a straight donation. Reason: The key to the deal is the bargain price arranged with the charity (i.e., the cash you’re receiving in the deal).

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