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Property subject to a liability.

1326. How is the amount of a charitable contribution affected when a taxpayer donates property subject to a mortgage or other debt?

When property subject to a liability is contributed to a charity, the amount of the liability is treated as an amount realized, even if the charity does not assume or pay the debt. (6) The property is considered sold for the amount realized, and the contribution is subject to the bargain sale rules (see Q 1325).

If, in connection with a charitable contribution, a liability is assumed by the charity, or if property is donated that is subject to a liability, the amount of the charitable contribution may not include any interest paid (or to be paid) by the donor for any period after the contribution if an interest deduction for the amount is allowable to the donor. (7) If the property is a bond, the contribution must be reduced by the amount of interest paid by the taxpayer on indebtedness incurred to purchase or carry the bond that is attributable to any period before the making of the contribution. However, the amount of such a reduction is limited to the interest or interest equivalent (e.g., bond discount) on the bond that is not includable in the donor's income. (8)

Example. (a) On January 1, 1992, Mr. Capps, an individual using the cash receipts and disbursements method of accounting, purchased for $9,280 a 5 1/2%, $10,000, 20-year Omega Corporation bond, the interest on which was payable semi-annually on June 30 and December 31.The Omega Corporation had issued the bond on January 1, 1992, at a discount of $720 from the principal amount. On December 1, 2002, Mr. Capps donated the bond to a charitable organization, and, in connection with the contribution, the charitable organization assumed an indebtedness of $7,000 that Mr. Capps had incurred to purchase and carry the bond.

(b) During the calendar year 2002, Mr. Capps paid accrued interest of $330 on the indebtedness for the period from January 1, 2002, to December 1, 2002, and an interest deduction of $330 is allowable for such amount. Of the bond discount of $36 a year ($720 divided by 20 years), $33 (11/12 of $36) is includable in Mr. Capps' income. Of the $550 of annual interest receivable on the bond, he will include in income only the June 30, 2002, payment of $275.

(c) The market value of the Omega Corporation bond on December 1, 2002, was $9,902. This value includes $229 of interest receivable that had accrued from July 1 to December 1, 2002.

(d) The amount of the charitable contribution determined without regard to the reduction required by IRC Section 170(f)(5) is $2,902 ($9,902, the value of the property on the date of gift, less $7,000, the amount of the liability assumed by the charitable organization). In determining the amount of the allowable charitable deduction, the value of the gift ($2,902) must be reduced to eliminate from the deduction that portion for which Mr. Capps has been allowed an interest deduction. Although the amount of such interest deduction was $330, the reduction required by this section is limited to $229, since the reduction is not to exceed the amount of interest income on the bond that is not includable in Mr. Capps' income. (1)

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Publication:Tax Facts on Investments
Date:Jan 1, 2010
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