The significant tax value of charitable contributions makes donating to organizations, such as museums, churches and educational groups, a win-win for individuals seeking an effective wealth planning strategy.
“The donation of art and collectibles is a tax win for the donor, both from an income tax perspective and because it removes the respective asset from the donor’s estate,” explains Harry F. Murphy, a director in the tax strategies group at Kreischer Miller, Horsham, Pa. “The charity also benefits since the tax exemption is perpetuated.”
Smart Business discussed with Murphy the tax treatment of charitable donations and how donors should plan gifts to realize the most benefits.
Do all charitable gifts qualify for tax deductions?
Prior to any gift transaction, the donor must verify that the charity is a qualified organization. This is easily accomplished by requesting a copy of the organization’s most recent IRS charitable status letter. This should also be verified by checking the IRS’ list of qualified charities in IRS Publication 78 or on its Web site: apps.irs.gov/app/pub78.
Are there deduction limitations based on an individual’s determined tax status?
Artwork and collectibles are tangible personal property and, for income tax purposes, have certain tax limitations. It must be first determined who is the owner of the property for tax status purposes. Is the owner or donor a collector, the creator, an investor or a dealer? Although the terms appear to be self-explanatory, they have specific tax definitions.
An individual who buys artwork or collectibles for personal use is a collector. The creator, of course, is the individual who created the property or participated in the creation. An investor is someone who buys and sells art and collectibles with a profit motive. Personal enjoyment is not a factor. Anybody who sells art and collectibles to clients or the public is deemed to be engaged in a trade or business.
In particular, how does the IRS treat collectors’ gift transactions?
Different tax treatment depends upon the individual’s determined tax status. Let’s focus on the collector and assume that the artwork or collectible is a capital asset. Since art and collectibles are tangible personal property, the donor must confirm that the donee will use the gift in such a manner that it is related to the donee exempt purpose. This is known as a ‘use-related’ donation. A use-related donation is deductible at its fair market value (FMV). It has a tax deduction limit of 30 percent of the donor’s adjusted gross income (AGI). If the FMV exceeds 30 percent of the AGI, the remaining unused deduction can carry over for up to five years.
If the charity will not use art or collectibles in a manner related to its exempt purpose, the donation is considered ‘use-unrelated’ and the deduction is limited for income tax purposes. Any tax deduction is limited to the initial purchase price or other tax basis in the art or collectible up to the normal 50 percent limitation of the donor’s AGI. The five-year carryover rule is also applicable. Therefore, it is critical that the donor find out how the donee will use the ‘gift.’
Are there tax traps associated with collecting artwork or collectibles?
There is a tax trap if the donor also holds a copyright regarding the art or collectible. In this situation, both the property and the copyright must be transferred to the donee charity. Another tax trap is where a donor reserves the right to keep the art or collectible in the donor’s control until some subsequent event, such as the death of the donor. This ‘future interest’ donation is not deductible until the donor no longer has ‘any interest’ in the property. This rule also applies if the artwork is held by the donor’s immediate family members.
The donation of art or collectibles must be supported by a qualified appraisal if the property is valued at more than $5,000. There are special rules regarding appraisers and, if not followed, the IRS may impose penalties. For large or substantial donations, the donor may request what is known as a Statement of Value from the IRS. An IRS user fee of $2,500 must be submitted along with a complete qualified appraisal. This approach eliminates any subsequent disputes with the IRS over the FMV of the donation.
What other planning techniques provide tax benefits on charitable gifts?
The use of a charitable remainder trust (CRT) is another planning technique. An irrevocable trust is created. The CRT pays a fixed income percentage from the trust to the donor (grantor of the trust) for a term of years (20 years is the limit). At the trust’s termination date, the donated property is passed to the charity. For income tax purposes, a charitable deduction is available to the donor based upon the IRS’s value of the remainder interest that will be passed to the charity. There is no income tax regarding the trust, and the remainder interest at the death of the donor is deemed not to be included in the donor’s estate. The donor must find a charity willing to participate in such a transaction. This is usually related to the potential value of the art or collectible.
HARRY F. MURPHY is a director in the tax strategies group at Kreischer Miller. Reach him at firstname.lastname@example.org or (215) 441-4600.