Suppose your clients have acquired some valuable artwork over time, but instead of donating cash to one of their favorite charities, they decide to gift an item from their prized collection. This could result in greater tax benefits than you would realize by simply writing out a check to the organization.
What you do need to know and be aware of is a potential pitfall that could cost them a sizeable tax deduction.
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Start with this basic premise: If they donate property that they’ve held for a year or less, the deduction is limited to your “basis” in the property, generally what they’ve paid for it. For example, let’s say you paid $10,000 for a sculpture 11 months ago and it’s now worth $12,500. If you donate it to a museum, your deduction will be equal to your cost, or $10,000.
On the other hand, if you’ve owned the property long enough for it to qualify for long-term capital gain had you sold it (i.e., for more than one year), you can deduct its fair market value (FMV) on the date of the donation.
Going back to our previous example, if you hold the sculpture just one month and a day longer, you may deduct its full FMV, or $12,500. Now you’ve increased your deduction by $2,500. Best of all, the appreciation while you owned the sculpture remains untaxed – forever.
Moreover, the tax law generally limits your current deduction for charitable gifts of property to 30 percent of your adjusted gross income (AGI) for the year. But you can generally fit easily under the 30 percent threshold.
In our example, if you have an AGI of $100,000, you can still deduct the full $12,500 FMV of the sculpture. In the event you exceed this limit, any excess is carried forward for up to five years.
However, there’s still that potential pitfall that we mentioned. The IRS says that your deduction is limited to your basis, regardless of the holding period, if the charity doesn’t use the work of artwork to further its tax-exempt purpose.
For instance, if you donate a painting to your alma mater and the school hangs it in a prominent place where students can study it, you may deduct the full amount. Conversely, if the school shoves the painting into a vault or promptly sells it, your deduction is limited to your basis (or its FMV if that’s lower than your basis). Make accessibility a condition of your gift.
Finally, you can’t simply pull the value of artwork out a hat. For property valued above $5,000, the IRS specifically requires you to attach an independent appraisal to your return.
The appraisal should include a description of the artwork, its condition and the method of appraisal, among other things. Icing on the cake: The cost of the appraisal is deductible itself as a miscellaneous subject to the usual “floor” of 2 percent of AGI.
Take all these factors into account when gifting art and other property to charity. As long as they’re careful, they’ll be rewarded for their generosity at tax return time.