Most financial institutions have worked their way out of holding other real estate properties. However, there are times when a bank may hold a property on its books that it can’t seem to find the right buyer for. There are several other options available to dispose of these properties. One way is to donate the property to a qualified charitable organization that could benefit from the donation.
Charitable Contributions of OREO Property
In general, a donee can deduct the fair market value of the property at the time of the contribution. However, if the bank contributes property that has a fair market value that is more than the taxable basis, the contribution may need to be reduced by the amount of appreciation. Contributions of ordinary income property, which include other real estate owned, are generally limited to the tax basis of the property. Therefore, the amount the bank can deduct as a contribution is the property’s fair market value minus the amount that would be ordinary income if the property was sold at its fair market value.
Donating other real estate property that has a tax basis in excess of fair market value should be avoided. The taxable deduction is limited to the fair market value of the property, and the bank would not be able to claim a loss for the difference. It would be more beneficial for the bank to sell the property at a loss, so the loss could be deducted. The proceeds of the sale could then be donated to a qualified charitable organization.
Bargain Sale of Property to Charity
Another potentially advantageous strategy to remove other real estate from the books is to enter into a bargain sale with a charitable organization. A bank that sells appreciated property to a charitable organization for less than the fair market value is considered to have made a sale and a donation to that organization. The part of the transaction that is a sale may result in a taxable gain. The bank must allocate its basis in the property to the sales price to determine the amount of gain to be recognized on the sale. The adjusted basis of the part sold is calculated by taking the adjusted basis of the entire property times the amount realized (sales price) divided by the fair market value of the entire property.
Example: A bank has an OREO property reported on its books with a tax basis of $75,000 and a fair market value of $100,000. The bank enters into a bargain purchase sale with a qualified charitable organization for $42,000. The bank would report a charitable contribution of $58,000 ($100,000 FMV – $42,000 sales price) and a gain on sale of property of $10,500 (42,000 – (($42,000 / $100,000) x 75,000).
The net effect of a bargain purchase sale may be more beneficial than an outright sale of the property or a 100% charitable contribution deduction.
If a bank is a C corporation, the amount of contribution deduction is limited to 10% of its taxable income. If the bank is unable to use the entire amount in the year of the donation, the contribution deduction can be carried forward to the next five taxable years. If the bank does not use it within five years, the deduction expires.
For an S corporation, the charitable contribution flows through to the shareholder and is reported at the shareholder level. There may be limitations at the shareholder level based on each individual shareholder’s tax position.
If a bank determines a donation to a qualified charitable organization is a method it may use to dispose of OREO property it is holding, the bank must keep records to prove the amount of the charitable contribution. In addition, for any contribution in excess of $5,000, the bank is required to file Form 8283 (Noncash Charitable Contributions) as part of its federal tax return in the year the donation was made. The bank is also required to obtain an appraisal of the property by a qualified appraiser. The appraisal cannot be dated earlier than 60 days prior to the date of the donation. The appraiser must complete and sign Part III of Form 8283. The bank must also receive written acknowledgment from the donee that the organization received the property and no goods or services were received in exchange for the donation. The donee also needs to sign Form 8283 acknowledging the receipt of the property.
There are times when a bank may hold other real estate on its books that it can’t seem to find the right buyer for. If a bank chooses to donate the property to a qualified charitable organization, the tax deduction will generally be limited to the lesser of fair market value or adjusted tax basis. Bargain sales to a charitable organization might yield a more beneficial result. In the end, careful attention should also be given to charitable contribution limitations and proper recordkeeping. If you are contemplating a donation of other real estate, we encourage you to contact your Wipfli tax advisor.