Estate Planning Newsletter
Donations of Property and Tax Deductions
The U.S. government has long encouraged citizens to contribute to charity. One method of encouraging philanthropic giving is the allowance of deductions from income for federal tax purposes for donations to “qualified” charitable organizations. Taxpayers may donate cash or real or personal property.
The rules and requirements for donations of cash are fairly straightforward. When property is donated, however, the rules and regulations become more complex. One major point of contention is assigning a value to what has been contributed to the charity. The general rule is the amount of the deduction is equal to the fair market value of the property.
Fair Market Value
The Internal Revenue Service (IRS) defines “fair market value” (FMV) as the price that would be agreed upon by a willing buyer and seller of the property, with neither being forced to act and both having reasonable knowledge of the relevant facts. Restrictions on use of the property must be reflected and usually reduce the FMV. The IRS suggests that factors that should be considered in determining the FMV include:
The cost or selling price of the item, providing the sale took place close to the date of the donation, was an “arms-length sale,” and the market for the property has not changed.
Sales of comparable property, depending on the degree of similarity, how recent the sale was, whether it was an “arms-length sale,” and conditions of the market at the time.
Replacement cost of buying, building, or manufacturing similar property on the date the property is donated (which may not be the same as FMV), less a depreciation amount.
Opinions of experts, evaluated based on the knowledge, competence, experience and thoroughness of the expert, and the supporting facts and investigation.
Some Examples of Donated Property and How FMV is Established
Donation of property may require a formal appraisal by an expert. Property worth less than $5,000 does not, in general, require an appraisal. The IRS has been known to subject appraisals to strict scrutiny.
- Used clothing and household goods – the FMV is usually substantially less than the purchase price. Sometimes the charitable organization will affix a value on the donation.
- Jewelry, artwork, antiques, or collectibles (coins, stamps, etc.) – usually must be supported by a signed, written appraisal, based on valuation factors similar to those above.
- Cars, boats and aircraft – often based on seasonal guides, such as the “bluebook” value for cars.
- Stocks and bonds – the value may be easily determined if the stock is traded on an exchange, including one that has “bid” and “asked” prices. A valuation discount for sale of a large block of stock may be reflected, as it may be more difficult to sell. Un-traded and/or closely held stock may be valued based on company net worth, earning power, and other relevant factors.
- Real estate – usually requires a detailed appraisal by a thoroughly-trained appraiser based on comparable sales, replacement costs, etc.
- Interest in a business – may be valued based on factors such as the FMV of the company’s assets, demonstrated earning capacity, and other factors used in valuing businesses.
- Annuities, interests for life, remainders, etc. – are valued at their “present value.” Money or property to be received in the future is subjected to a “discount factor,” reflecting inflation rates, etc., to determine a reduced present value.
Contributions of Some Property Treated Differently
Different rules may apply to donations of:
- Property subject to debt – the FMV of encumbered property is subject to deductions to reflect the amount of any encumbrance on the property.
- Partial interests in property – generally, a donation of property is not deductible if it is less than the entire interest the taxpayer owns in the property. Exceptions include a remainder interest in a home or farm (i.e. the taxpayer stays there for life, then it passes to the charity), or a partial interest that would be deductible if transferred to a trust.
- A future interest in “tangible personal property,” – i.e., property, other than land or buildings, which can be seen or touched, such as furniture, book, jewelry, artwork, or cars. The donated interest would begin in the future.
- Inventory (property sold in the course of a business) – the value for the deduction is the smaller of its FMV or its “basis,” usually the purchase price, subject to some adjustments.
- Property that has increased in value since being acquired by the taxpayer – in general, the value of the deduction for such property may have to be reduced by the amount of the increase in value. Different rules may apply for this calculation, depending on whether the increase in value would be subject to tax treatment as ordinary income or capital gains, if the property were sold by the taxpayer.
Penalties for Overstatement of Value of the Property
There is an assessed penalty of 20% of the amount by which the taxpayer underpaid because of the overstatement of value if: the value of the adjusted basis claimed on the return is 150% or more of the correct amount, and taxes were underpaid by more than $5,000 because of the overstatement in value of the donated property.
The penalty can be 40% of the amount by which the taxes were underpaid if: the value of the adjusted basis claimed on the return is 200% or more of the correct amount, and taxes were underpaid by more than $5,000 because of the overstatement in value of the donated property.