It’s being called the “best kept secret in commercial real estate.”
The IRS 170 Exchange, otherwise known as the Bargain Sale transaction, could play a crucial role in getting some properties off the market in some of Alabama’s communities.
Shawn Marcel, senior acquisitions manager at The Welfont Group, will be a presenter at the 17th annual Alabama Commercial Real Estate Conference on Feb. 10 at The Club in Birmingham. Marcel is an expert on the Bargain Sale transaction.
Marcel, who will speak during the afternoon session at ACREcon, has worked on multiple deals involving the sale of properties to nonprofits or 501(c)3 entities. Marcel said these transaction types can help properties sell faster and eventually give a shot in the arm to the neighborhoods where they sit.
We caught up with Marcel recently, and he answered a few questions about the 170 Exchange and gave a sneak peak into what he’ll be discussing at ACREcon.
ACRE: One of our themes for ACREcon this year is revitalization of downtown areas. How can the IRS Bargain Sale benefit urban areas in Alabama cities?
Marcel: The IRS Section 170 Bargain Sale is a great tool for the commercial real estate broker to have in their tool bag. Written into law by Congress almost 100 years ago, this real estate transaction can help to reinvigorate secondary, tertiary and less desirable markets.
Assume for a moment that your client has a vacant manufacturing facility on the outskirts of the downtown core. It has been a vacant building for the past 12 months, since the most recent tenants moved out, adding to blight. This property does not create jobs, increase the tax rolls or improve the area. If anything, it is doing the exact opposite, as it may attract vandalism or worse.
By selling this property to a 501(c)(3) nonprofit through a Bargain Sale transaction, the property owner gets to value the property at its highest and best use, not the current lower value. The valuation should be done by a certified appraiser with the MAI designation. It is then sold to the nonprofit at the highest and best use appraisal. The seller receives a minority portion of this value in cash at closing and the remainder is received as tax deductions and rebates from the state and federal governments.
It is important to understand that the charity is under no obligation to hold the property for any length of time or to sell it for the highest and best use appraised value. This opportunity allows the charity to offer the property for a much-reduced price, which encourages the property’s resale, giving the property the opportunity to get back into full use.
The Bargain Sale transaction is a win-win-win-win … for the seller, for the broker, for the charity, for the neighborhood and the municipality. Whether the reuse is for manufacturing or another type of facility, the property gains the ability to thrive, triggering the rebirth of a community.
ACRE: Describe what the IRS Bargain Sale is.
Marcel: The IRS Section 170 Bargain Sale was introduced in 1917 and updated in the ’50s. In the IRS Section 170 Bargain Sale, a donor sells a piece of property to a charity for below the fair market value price. The seller can then write off the total amount less than fair market value as a charitable donation for tax purposes. This allows the company to both receive capital for the property sold, as well as a charitable contribution tax deduction. Additionally, the donor can bypass the taxable gain on the gift portion of the sale. Successful commercial real estate investors use the IRS Section 170 Bargain Sale as a tax strategy. This strategy encourages philanthropy among profit-earning companies.
IRS 170 Transaction Rules
- The donor/seller must have enough taxable income to qualify for this type of deduction.
- The buyer must be a federally recognized 501(c)(3) entity.
- A dedicated MAI designated appraiser must evaluate the property.
- An IRS 561 independent appraisal must take place within 60 days of the transaction.
The main distinction of the IRS Section 170 Bargain Sale from other tax benefits is its immediate tax savings, not just a deferral. There are no limits, really, but there are certain types that may be more advantageous for the seller. A large, outdated, vacant manufacturing facility is a good example of this type real estate transaction. This type of property tends to be slower to sell and has high carrying costs, plus management fees. All of these variables translate into steep losses for the property owner.
The IRS Section 170 Bargain Sale allows the property owner to make a donation of the entire property, or part of it, to a government-recognized nonprofit. The nonprofit then can keep or sell the property to help fund their work.
The 3 Key Seller Benefits
- The seller receives a substantial amount of cash at closing.
- The seller receives a substantial charitable deduction for the remainder of the full and true, fair market value.
- The seller enjoys the satisfaction of being able to help others.
The 5 Key Broker Benefits
- The broker receives a substantial commission based on the total cash benefit to the seller.
- The broker often sells an illiquid property at the current price for the client.
- The broker, having sold a hard-to-sell property for the client, can gain valuable referrals.
- The broker may have the opportunity to relist the property for the charity buyer.
- The broker enjoys the satisfaction of being able to help others.
The 3 Key Nonprofit Benefits
- The nonprofit receives cash.
- The nonprofit obtains property.
- The nonprofit is able to expand its mission with the funds from the transaction.
ACRE: How can the average CRE broker utilize the IRS Bargain Sale?
Marcel: When considering the IRS Section 170 Bargain Sale transaction, here are a few questions to ask:
- Is the property in a secondary or tertiary market?
- Is the most recent property use no longer a current option?
- Would the property sell easier if it was for a new/different use?
- Is the seller ready to cash out of a 1031 Exchange?
- Does the seller have a large tax liability?
The most obvious property for a Bargain Sale is one that is in a secondary or tertiary market with no ability to sell in a reasonable time frame at a fair market value. This property is perfect for a Bargain Sale.
It will usually be able to appraise at a higher value because the MAI-designated appraiser will do the appraisal based on section 561 of the tax code. When determining fair market value for a 561 appraisal, the appraiser may factor in highest and best use. So, for example, if zoning allows, a historic house or vacation home may have higher value if appraised as a bed and breakfast, even though it is not currently being used in that fashion. If three homes were clustered together in the old town center, if valued as a package, their highest and best use might be for a drug store.
A seller with a 1031 exchange or large tax liability may be a perfect fit for a Bargain Sale transaction. Just ask your seller about their tax liability. The tax benefits can be used in the current year and for up to five additional years. For a seller with a high tax liability, a tax credit is CASH. Obviously, the Welfont Group is not a CPA firm, so we are not in the business of providing tax advice. Instead, we are a great resource for your client’s CPA to talk to. We can explain the transaction and the CPA can determine if the seller can benefit from the tax benefits.
The bottom line is that for the right seller or property, the IRS Section 170 Bargain Sale transaction creates a GREAT option.
ACRE: Can you talk about a couple of deals that you have worked on in particular that are good examples of how this program can be used and benefit an area?
Magic Valley Frozen, McAllen, Texas; 145,000 square feet on 16 acres
Marcel: Magic Valley was founded 45 years ago producing frozen vegetables for distribution to major food outlets and institutional buyers throughout the United States. Magic Valley moved into a larger facility that better accommodates its employees and produce lines. The company wanted to liquidate its old facility without going through a lengthy selling process with deals that do not close.
Upon speaking with Welfont acquisitions manager Larry Surowiecki, Magic Valley considered using a Bargain Sale and completed a successful transaction to a nonprofit entity. After reviewing the IRS Section 170 Bargain Sale offer, they were convinced and hired an independent MAI-designated appraiser. The new 561 appraised value, based on IRS publication 561, was for the full and true, fair market value of nearly $6.3 million. This higher appraised value allowed for a significant amount of cash at closing and a sizable amount of cash from federal and state governments in the form of tax reductions.
Griner Drilling Service, Columbia, Miss.; 100,000 square feet on 38 acres
Marcel: The Orleans Furniture company, a tenant of Griner Drilling Service, had been operating in a 100,000-square-foot building in Columbia, Mississippi, about 35 miles outside of Hattiesburg. After many years in business, the furniture company closed its doors, leaving Griner Drilling with a vacant property. The original asking price, considering the property’s size and best use, was too much for the surrounding area and left the building vacant with no end in sight. With years of carrying costs and no prospective buyers, the property was a burden on the company’s portfolio.
Ryan Ruhge, senior acquisitions manager at the Welfont Group, contacted the listing broker, Stephen Stetelman, with an offer. The offer, an IRS Section 170 Bargain Sale transaction, was a new concept to Mr. Stetelman. Although he had never heard of a Bargain Sale, he brought the offer to the Griner Drilling CFO.
After reviewing the Bargain Sale offer, Griner Drilling became convinced and hired an independent MAI-designated certified appraiser. The new appraised value of $3 million was based on IRS publication 561, representing the full and true, fair market value. This higher appraised value allowed for a smaller yet significant amount of cash at closing and a sizable amount of federal and state governments tax reduction.
The IRS Section 170 Bargain Sale requires the transaction to be with a 501(c)(3) nonprofit. The Welfont Group has a large stable of nonprofits interested in participating in these transactions. The charity of choice for this transaction was ACTS Community Development, which runs Coney Island Lighthouse Mission, a charity for people in need in Coney Island.
ACRE: How does the broker get paid on an IRS Section 170 Bargain Sale transaction?
Marcel: One of the questions that brokers often ask me is, “How do I get paid?” Since the transaction is a bit different from the traditional sale, their concern is understandable. The first thing that a broker sees is that the cash as closing is a minority share of the property value. But remember that, to the seller, the tax benefits can be considered CASH. So commissions are based on the cash benefit that we were able to generate for the seller. This scenario allows us to generate a market commission paid against the cash benefit, often resulting in as much as or close to what a traditional commission would pay out.
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