For your clients that donate or shop for donated clothing, they should be aware of a recent Tax Court case that found you can’t deduct the full retail cost of brand-new clothing that’s been discounted.
If your clients donate old clothing or toys stored in the basement or attic, they can deduct the current fair market value (FMV) of the items, as long as they itemize deductions. Obviously, the better the condition the items are in, the bigger the deduction.
However, the basic rule is that you can deduct an amount equal to the fair market value (FMV) of used property on the date that you contribute the property to charity. For instance, if you bought a suit or dress for $500 and it’s worth $1,000 when it’s donated to charity, your deduction is limited to $1,000.
Other special rules may come into play. Notably, no deduction is generally allowed unless the item is in good condition. In addition, the IRS requires you to obtain an independent appraisal for items valued above $5,000 and to attach the appraisal to your tax return.
The taxpayer in the new case, Grainger, TC Memo 2018 – 117, 7/30/18, was a retired grandmother living in Maryland, was fond of shopping. In 2010, seeking to combine her hobby with a desire to cut taxes, the taxpayer developed what she described at her “personal tax shelter.”
Here’s how it worked: The taxpayer looked for clothing that had been heavily discounted (e.g., out-of-season items) and purchased hundreds of these items during the course of the year. As a valued customer of the retailer, she would become entitled to “points” or “appreciation dividends,” which she could then deploy to get further discounts.
For example, as a result of successive markdowns and use of “points,” the taxpayer might purchase an item for $10 that had an original retail price of $99. She would donate that item to Goodwill and claim a charitable deduction for a $99 contribution on her federal tax return.
But the IRS challenged her deductions on three grounds:
1. The taxpayer failed to obtain an appraisal of the items contributed. This is the tax return requirement if the aggregate value of similar items exceeds $5,000.
2. The taxpayer didn’t establish that the FMV was higher than her purchase price. Thus, the IRS only allowed a deduction equal to the amount the taxpayer paid for the clothing.
3. The taxpayer didn’t have the organization properly substantiate her contribution. She didn’t obtain a signed acknowledgement from the charity as required by law.
Tax outcome: The Tax Court sided with the IRS. It noted that many of the items had already been marked down in price, thus reducing their FMV. Accordingly, it limited the deduction to the amounts the taxpayer actually paid for the clothing.
How do you establish the FMV for gifts of used clothing and other items? You may rely on various guidelines posted online.
About Ken Berry
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.