A N I N C O M E , E S TAT E A N D G I F T TA X
S E RV I C E F O R AT TO R N E Y S A N D OT H E R
P RO F E S S I O N A L A DV I S O R S
THIRD QUARTER, 2007
Charitable Gifts of Tangible
Personal Property In this issue:
Charitable gifts of tangible personal property — i.e., physical, • Tax rate for long-term capital gains
“touchable” assets such as antiques, artwork, precious gems
and coins — are subject to valuation and deduction rules that on tangible personal property
may affect their suitability for charitable giving. In this issue,
we review important considerations applicable to charitable • The ordinary-income reduction rule
gifts of tangible personal property (TPP), including opportuni-
ties for your clients and potential pitfalls that you should help • The related-use rule: a potential
them to avoid. This issue should be particularly relevant due
to stricter rules introduced by the Pension Protection Act of
• Gifts of undivided interests
I. 28 Percent Income Tax Rate Applies to Long-
Term Capital Gains on Tangible Personal
The Tax Increase Prevention and Reconciliation Act (signed
into law on May 17, 2006) extended the current law’s top tax Like the gift of XYZ Stock, the gift of TPP can generate a
rate on net long-term capital gains at 15 percent for most charitable deduction of $50,000 (subject to important qualifi-
types of capital assets. This 15 percent rate is in effect cations we will discuss shortly), but the TPP is the gift proper-
through December 31, 2010. However, there are exceptions, ty of choice because $4,550 of “extra” capital gains tax can be
including one concerning the tax rate for TPP Gain on the avoided by donating the TPP rather than the XYZ Stock.
sale of appreciated, long-term TPP remains subject to a tax
rate of 28 percent — the rate for long-term gain on most II. Ordinary-Income Reduction Rule May
types of capital assets before enactment of the Tax Relief Act Decrease Charitable Deduction
of 1997. A gift of appreciated TPP to charity generally is deductible at
While the 28 percent rate makes appreciated TPP a less its fair market value (subject to the overall 30-percent-of-AGI
attractive option than other capital assets to sell from a tax limitation), provided the property has been held long-term.
liability standpoint, the 28 percent rate conversely makes TPP The amount of the deduction, however, must be reduced by
a better choice for charitable giving than a similarly situated any gain that would have been ordinary income or short-term
intangible personal asset such as a stock or shares in a mutual capital gain if the property had been sold for its fair market
fund. More capital gains tax can be avoided when clients value on the date of the gift [IRC §170(e)(1)]. Assets subject
make a gift of the TPP in lieu of another capital asset that is to this reduction include:
subject to a 15 percent top tax rate on the long-term capital • Appreciated property held for sale in the ordinary course of
gain. Consider the following illustration: the donor’s trade or business (e.g., a manufacturer’s inven-
tory, a dealer’s stock-in-trade, artworks or manuscripts cre-
XYZ Stock TPP Item
ated by the donor);
Fair Market Value $ 50,000 $ 50,000
• Appreciated property subject to recapture;
Cost Basis –15,000 –15,000
• Appreciated short-term capital assets; and
Net Long-term Capital Gain 35,000 35,000
• Certain kinds of appreciated stock, the gain on which
Capital Gains Tax $ 5,250 $ 9,800 would not be long-term capital gain if the stock were sold.
TECH N I Q U E S — T H I R D QUART E R 2 0 0 7
III. Exceptions for Certain Book Inventory which the charity was awarded its tax-
Types of Inventory Similar to food inventory, the Katrina exempt 501(c)(3) status [IRC
Emergency Tax Relief Act of 2005 (and §170(e)(1)(B)(i)].
Contributions to Benefit the Ill,
extended by the Pension Protection Act) If a collection has been donated to chari-
Needy or Infants
included a provision to permit C corpora- ty, the charity’s related use of the gift will
Contributions of inventory by C tions the same enhanced deduction for not be undermined if the charity sells or
Corporations to public (qualified) chari- gifts of book inventory to elementary and otherwise disposes of an “insubstantial
ties are reduced by only one-half of the secondary public schools effective for part” of the collection [Reg. §1.170A-
amount that would have been ordinary contributions made after August 28, 2005 4(b)(3)(i)].
income upon a sale when such inventory and through the end of 2007.
is used for the care of the ill, needy or Many donors are surprised to learn that
infants [IRC §170(e)(3)]. The limit on IV. Contributions of Used Motor they bear the burden of determining
the donor’s deduction is the property’s Vehicles, Boats and Airplanes whether the charity will put the TPP to a
tax basis plus one-half of the apprecia- related or unrelated use. A donor may
In response to perceived abuses in the
tion, though only up to a limit of twice treat the TPP as having been put to a
gifting of used vehicles (inflated values
the property’s basis. The meaning of related use if:
that donors deducted compared to what
“care of the ill, needy or infants” is
the charity actually realized on selling • The donor determines that the charity
defined in Reg. §1.170A-4A(b)(2)(ii).
the vehicle) Congress enacted IRC has not in fact put the TPP to an unre-
Scientific Research Equipment §170(f)(12) as part of the American Jobs lated use, or
Creation Act of 2004. Under the new
A corporate donor (though not an S cor- • At the time of the gift, the donor
rules, for gifts over $500, the amount of
poration, personal holding company or could reasonably anticipate that the
the taxpayer’s deduction is limited to the
service organization) who contributes property would not be put to an unre-
gross proceeds received by the charity
newly manufactured scientific equipment lated use by the charitable donee [Reg.
upon sale of the vehicle. Furthermore, in
to a college, university or scientific §1.170A-4(b)(3)(ii)].
order to reflect fair market value it had to
research organization for use in research, The donor should obtain written confir-
be in an arm’s length transaction between
experimentation or research training may mation of the charity’s related-use plans
unrelated parties. The donor completes
claim an income tax charitable deduction for the property in advance of making a
Form 8283 detailing the information on
equal to its tax basis plus one-half of the TPP gift.
the value of the contributed vehicle to be
appreciation in the property [IRC
filed with the tax return. In the event the
§170(e)(4)]. Like the contributions of “Related Use” Is Not Always Clear
charity disposes of the vehicle within
inventory by a C corporation noted A “related use” may be found to exist
three years of its contribution, the charity
above, the limit on the donor’s deduction even when it is not apparent upon curso-
needs to complete Form 8282. Note there
is the property’s tax basis plus one-half of ry examination. The IRS ruled that etch-
are exceptions to limiting the deduction
the appreciation, though only up to a ings of wildlife donated to a state and dis-
to the gross proceeds (i.e. a donor may
limit of twice the property’s basis. The played to the public in state office build-
deduct the fair market value even if the
corporate donor should secure written ings qualified as a related use [Ltr. Rul.
vehicle is sold for less than that fair mar-
confirmation from the charity as to the 8301056]. The donation of a stamp col-
ket value to a needy individual in direct
planned use of the donated equipment. lection to a university was ruled a related
furtherance of the organization’s charita-
ble purpose of relieving the poor, dis- use when the collection was displayed in
tressed or underprivileged in need of the university’s art gallery and was used
The Katrina Emergency Tax Relief Act of by the university’s art students [Ltr. Rul.
2005 included a provision that extended 8208059]. The donation of porcelain art
the enhanced deduction that C corpora- V. The Related-Use Rule: A objects to a not-for-profit retirement
tions enjoy for gifts of inventory to all Potential Pitfall for Your home was ruled a related use because the
entities engaged in a trade or a business donated objects improved the quality of
in regard to food inventory. Recently, the the residents’ living environment [Ltr.
Pension Protection Act of 2006 extended The deduction for a gift of appreciated
TPP may also be reduced by the gain that Rul. 8143029; see also Ltr. Rul.
the food inventory deduction through the 8247062]. But the donation of a horse to
end of 2007. However, the total amount would have been long-term capital gain
had the property been sold at its fair mar- a cancer charity was not a related use,
of the deduction is limited to 10 percent and the donor’s deduction was reduced
of the taxpayer’s net income from all sole ket value on the date of the gift. This
reduction is triggered when the charity’s by the “built-in” long-term capital gain in
proprietorships, corporations, or partner- the horse [Coleman v. Comm’r, T.C.
ships from which contributions of “appar- use of the donated TPP is unrelated to
the charitable purpose or function for Memo 1988-538].
ently wholesome food” are made.
CH A R ITA BLE GIFT S O F TA NGIBLE P ER SO NA L PROPERTY
VI. Recapture of Tax Benefit it to charity but retains the right to pos- Thus, while a donor cannot currently
on Property Not Used for sess and enjoy the artwork for the rest of deduct a gift of a future interest in TPP ,
Exempt Purpose his or her life, no deduction arises at the he or she can “time-share” TPP with a
The Pension Protection Act of 2006 time the remainder rights are assigned to charity and secure a current deduction.
included new rules regarding gifts of TPP charity (plus, the partial interest rule of However, the value of the charity’s inter-
for which a donor has taken a charitable IRC §170(f)(3)(A) may also be violated). est may have to be discounted because it
deduction at fair market value based on However, an income tax charitable represents only a partial interest in the
its related use. If the donee charity dis- deduction may be allowed (subject to property [see Rev. Rul. 87-37, 1987-1
poses of the property within three years other limitations on the charitable C.B. 295; Estate of Fawcett v. Comm’r, 64
of its contribution, the donor must adjust deduction, including the partial interest T.C. 889 (1975)].
his claimed tax benefit as follows: rule) when all intervening rights have
The Pension Protection Act of 2006 has
expired or passed to a person other than
• If the charity disposes of the property further restricted the gift of an undivided
the donor or someone closely related to
in the same tax year as the contribu- interest in TPP .
the donor [IRC §170(a)(3)].
tion, the donor may only claim his or • Under the new law, the entire interest
her basis in the property, not the fair There is no similar restriction for federal
in the property must be transferred to
market value. estate and gift tax purposes. However, a
the charity within ten years of the ini-
partial-interest gift or bequest generally
• If the charity disposes of the property tial fractional contribution, or upon
must be made in the form of a charitable
in year two or three after the year of the donor’s death (whichever event is
remainder trust to be gift or estate tax
the contribution, the donor must earlier).
deductible [IRC §§2522(c)(2)(A),
include as ordinary income an amount 2055(e)(2)(A)]. A gift or bequest of TPP • If the charity fails to take physical pos-
equal to the excess (if any) of (i) the to these charitable vehicles is generally session during the period described or
amount of the deduction previously appropriate only when the trustee plans fails to use the property for an exempt
claimed as a charitable contribution to sell the property, because the donor’s use, all prior charitable income and gift
with respect to such property over (ii) deduction is postponed until the TPP is tax deductions claimed by the donor
the donor’s basis in such property at sold [see Ltr. Rul. 9452026]. will be recaptured, plus interest plus an
the time of the contribution. additional tax of 10 percent.
This recapture provision applies to
VIII. Gifts of Undivided
• Subsequent contributions of an undi-
deductions of more than $5,000. Interests vided interest in the property will be
Tax law generally denies a charitable limited to the lesser of either the initial
There is a safe harbor provided for deduction for gifts of partial interests
donors if a charity provides a certified value used as the fair market value, or
[IRC §170(f)(3)(A)], with certain impor- fair market value at the time of the
writing to show either that the property tant exceptions. One such exception is
was properly used, or that a related use later contribution. This limit applies to
for gifts of an “undivided portion of a income, gift and estate taxes. Note
was contemplated at the time the gift was taxpayer’s entire interest in property”
made, but that later circumstances made that this limit could create an unwel-
[IRC §170(f)(3)(B)(ii)]. The interest come result in the form of additional
the intended use impossible or infeasible donated to charity must consist of a por-
to implement. estate taxes should the donor die with-
tion of each and every substantial right in ten years from the initial fractional
New penalties are imposed for any person or interest owned by the donor, and it gift without gifting the entire interest
that identifies property as having a relat- must extend over the entire period of the in that property.
ed use knowing that it is not intended for donor’s interest [Reg. §1.170A-
such use. 7(b)(1)(i)].
Note that the charity reporting require- ,
In the case of TPP the undivided interest
ments for the sale of contributed property is often a fractional interest in art
have been extended from two years to objects, which may be expressed as a
three years. number of months per year. For example,
a donor might donate to a university the
VII. No Current Deduction for right to exhibit a painting for six months
Gift of Future Interest in each year, or perhaps for that portion of
Tangible Personal Property the year which coincides with the aca-
No income tax charitable deduction is demic year [see Ltr. Rul. 9303007]. The
allowed at the time of the gift for a gift of donor reserves the right to possess and
a future interest in TPP For example, if
. enjoy the painting during the balance of
the owner of a valuable artwork donates the year.
N e w Ta x D e v e l o p m e n t s
The IRS recently published two separate 2008. An applicable insurance contract is any life
Notices seeking comments pursuant to new insurance, annuity, or endowment contract in which
requirements under the Pension Protection both an applicable exempt organization and a per-
Act of 2006. son other than an applicable exempt organization
have directly or indirectly held an interest (whether
Notice 2007-21 seeks comment on an ongoing study or not at the same time).
concerning Donor Advised Funds and outlines spe- Notice 2007-21, 2007-9 IRB 1; Notice 2007-24, 2007-
cific questions including: 12 IRB 1
• What are the advantages and disadvantages of
donor advised funds and supporting organizations
to the charitable sector, donors, sponsoring organi-
zations, and supported organizations, compared to 2006 Art Advisory Panel Publishes its
private foundations and other charitable giving Annual Summary Report
The Art Advisory Panel meets every year to deter-
• How will new excess benefit restrictions change mine the correct valuation of art objects as both
the practices and behavior of donors, donor charitable contributions and estate assets. The
advised funds, sponsoring organizations, support- Annual Summary Report describes the closed meet-
ing organizations and supported organizations? ing activity of the panel. The report outlines the pro-
• Should there be any reduction in the deduction cedures of the Art Advisory Panel, provides a list of
depending on donor control over the assets con- panelists and summarizes the art items reviewed
tributed to the donor advised fund or the type of during the year by the panel broken down by estate
asset donated? and charitable contribution.
For 2006, the panel reviewed 1638 items with an
• What would be appropriate payout requirements
aggregate taxpayer valuation of $219,199,100 on 124
for a donor advised fund?
taxpayer cases under consideration. The claimed
• What are the advantages and disadvantages of per- value of the average charitable contribution item
petual existence of donor advised funds or sup- was $124,250 and the average estate and gift item
porting organizations? was $134,122. The panel recommended total adjust-
Notice 2007-24 seeks comment on draft forms that ments of $126,535,800. On the adjusted items, the
address a reporting requirement for charities and cer- panel recommended adjustments amounting to a 57
tain other entities with respect to certain structured percent reduction on the overvalued items in chari-
insurance contracts. The reporting requirements table contribution claims and a 95 percent increase
cover those organizations which acquire an applica- on the undervalued items in estate and gift
ble insurance contract in a reportable acquisition appraisals. Adjustments were recommended on 61
after August 17, 2006, but on or before August 17, percent of the reviewed appraisals.
This newsletter is for information and discussion purposes only. It is provided with the understanding that the publisher does not intend to render legal, accounting or tax
advice. Each professional must evaluate the tax and financial consequences of each individual situation. While the publisher has been diligent in attempting to provide
accurate information, the accuracy of the information cannot be guaranteed. Laws and regulations change frequently, and are subject to differing legal interpretations.
Accordingly, the publisher shall not be liable for any loss or damage caused or alleged to have been caused by the use or reliance upon the information in this newsletter.