With the holiday season fast approaching, the following article reviews the basic rules that are applicable to noncash charitable contributions to enable the reader to become aware of the substantiating requirements that are mandated by the IRS when noncash charitable contributions are made.
Transferring cash is the simplest way to make a tax-deductible donation. Unlike property, cash need not be valued, nor is the value subject to IRS challenge if properly substantiated. Costs associated with transferring title to property are avoided.
A property contribution by individual donors is subject to more complex rules for determining the amount of the deduction and the applicable percentage limitation. Depending on the property’s nature, the donee’s identity, and how the donee uses the property, the deduction may be donor’s basis in the property, its fair market value (FMV) or something in between. The applicable percentage limitation for individuals also depends on the type of property donated and the type of donee.
Although some types of property are relatively easy to value (e.g., publicly traded securities) others are more subjective. Also, most contributions for which a deduction over $5,000 is claimed and certain donations of used clothing and household items that are not in good condition require a qualified appraisal to support the deduction. This is true regardless of whether the taxpayers’ deduction is limited to the property’s tax basis, rather than being fully deductible at market value (FMV). The cost of the appraisal is borne by the donor (although it may be claimed as a miscellaneous itemized deduction subject to the 2% of AGI floor).
Ordinary Income and Short-term Capital Gain property
The charitable contribution deduction for ordinary income property is limited to its FMV less the amount that would be ordinary income if that property were sold. This generates a deduction essentially equal to the taxpayer’s cost basis. Ordinary income property is any property that, if sold, would result in ordinary income or short-term capital gain. Ordinary income property includes:
- Capital assets held for 12 months or less,
- Property created by the donor (e.g., works of art, literary compositions, etc.),
- Inventory, and
- Stock-in-trade
Long-term Capital Gain Property
Contributions of long-term capital gain property to charities are usually deductible at FMV, and the donor generally does not recognize gain when appreciated property is donated. Therefore, donating appreciated property is usually preferable to selling the property and contributing the proceeds, since donating the property avoids recognizing the realized gain and the payment of the tax that may be due on such gain.
Tangible Personal Property
When considering donations of tangible personal property and the maximum tax benefit is desired, the property should be given to the charity that uses such property in its exempt function. If the charity uses the property for a purpose unrelated to the charitable activities for which the organization was granted its tax-exempt status, the deduction is limited to the donor’s basis, rather than FMV.
For example, Sharon contributed a painting valued at $5,000 (tax basis of $750) to University of Connecticut (UCONN). The painting was sold by UCONN in its annual fundraiser and all proceeds were used for education purposes. Because the painting was not used for the organization’s purpose (instead, the proceeds from the sale were used for the University’s purpose), Sharon’s contribution is limited to $750. If the painting had been placed in the UCONN’s library for display and studied by art students, the use would have been related to the exempt function, and Sharon would be able to claim a deduction of $5,000. It should be noted that the unrelated use rule only applies to tangible personal property. If real property or intangible property (stock) is put to an unrelated use, the deduction is not limited under this rule.
Property that has decreased in value
The contribution deduction for a charitable gift of property that has decreased in value is limited to the property’s FMV at the time of contribution. Therefore, it usually is more beneficial to sell the property, deduct the loss and donate the proceeds. However, if the donated property is not used in a trade or business or held for investment, a loss on its sale is generally not deductible, so donating property would produce the same tax result as selling the property and donating the proceeds.
Documentation required to sustain a deduction
The record keeping and filing requirements for noncash charitable contributions vary based on type and the amount of the contribution. The IRS issued Publication 1771, “Charitable Contributions-substantiation and disclosure requirements”, to help taxpayers and charities understand the rules for documenting charitable deductions of federal tax return. A copy of the publication is available on the IRS website at www.irs.gov
Generally, property contributions must be substantiated with a receipt from the done showing the donee’s name, the date and the place of the contribution, and the description of the property. For property contributions valued at more than $500 and up to $5,000, Part A of form 8283 (Noncash Charitable Contributions) must be attached to the return. The taxpayer must also keep written records that include:
- The name and address of the donee;
- The date and location of the contribution;
- A description of the property;
- The property’s FMV on the contribution date, including the method used to value the property, and if used, a signed appraisal;
- How the property was acquired (e.g., purchase, gift, bequest); and
- The property’s cost or other adjusted tax basis.
Property contributions over $5,000.
Property contributions over $5,000, with certain exceptions, have strict reporting rules. Taxpayers must complete Part B of Form 8283 (Noncash Charitable Contributions), which requires the taxpayer to obtain a qualified appraisal by a qualified appraiser to document the donated property’s value. This is true regardless of whether the taxpayer’s deduction is limited to the property’s tax basis, rather than being fully deductible at FMV. However, appraisals are not required for the following types of property:
- Nonpublicly traded stock valued at $10,000 or less,
- A vehicle, if the deduction for the vehicle is limited to the gross proceeds from its sale,
- Intellectual property (i.e., a patent, copyright, trademark or trade name, etc.),
- Certain securities considered to have market quotations readily available,
- “Qualified contributions” of inventory donated by a corporation for the care of the ill, needy, or infants, or
- Stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business.
