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 [email protected] or (215) 441-4600.
