Your clients are always looking for ways to lower their tax burden. One clever strategy some may wish to utilize is the “purchase to donate to charity” (PDC) strategy. This is a multi-step tax strategy that takes advantage of the deduction allowed for charitable contributions.
In this post, we will discuss the mechanics of the PDC strategy. We will also discuss the potential objections that can be raised against it.
The mechanics involve several steps. In many cases, those who utilize the deduction for charitable contributions donate cash or stock. But it is possible to donate other types of property, such as clothing.
The problem with giving property is that such donations usually yield deductions far lower than the original purchase price. The PDC strategy involves donating property that is purchased for below market value for the purpose of taking a deduction for its full market value. This will require that the property be purchased outside of the retail market.
After donating the property for its full fair market value, the taxpayer takes a deduction, which leads to a financially net-positive result. Though the taxpayer made a purchase, the price is less than the decrease in tax liability which results from the deduction.
Let’s look at a hypothetical. A taxpayer buys an antique or painting from a private sale for $100. But, according to most experts, the item's value is actually $1,000. Let’s assume this individual is in the 30 percent tax bracket.
When the taxpayer donates the property to a qualified charity, they will take a deduction for the full fair market value of $1,000. Consequently, they will reduce their tax liability by $300 because the taxpayer would have paid this amount in tax if their income hadn’t been reduced by $1,000. With the use of the PDC strategy, the taxpayer has created a net positive gain of $200.
However, the PDC strategy is vulnerable to objections by the IRS, which has special rules for the valuation of property that is donated to charitable organizations. If an accountant decides to counsel a client on the PDC strategy, they will need to be familiar with these rules.
Taxpayers can deduct the full market value of antiques, paintings and other similar property donated, but it may need to be substantiated by an official appraisal. If taxpayers intend to deduct $5,000 or less for such property, generally, an appraisal is not required. If taxpayers wish to donate property other than antiques or paintings, they will have to comply with other full market value substantiation requirements.
The availability of the PDC strategy is limited to property that can be deliberately purchased for below market value. This may not appear to be very practical to some, but for those who attend private sales or frequently acquire property in a non-retail setting, it can be quite viable.
Jorgen Rex Olson is a graduate of Washington State (B.A., cum laude, 2008) and the Indiana University (McKinney) School of Law (J.D., 2012). He writes for Mackay, Caswell & Callahan, P.C., one of the leading tax law firms in New York State.