Before committing yourself to donating your fine art to a qualified charity, it is essential to know the limitations of your tax deduction for philanthropic giving. A widely-held belief by donors of non-cash property is that 100% of your gift’s fair market value can be deducted immediately against their income. [1] Right? Wrong!
The IRS dramatically limits the amount of your income tax deduction for your charitable in-kind gifts in any given single year. Additionally, the IRS further limits the amount of your charitable gift of in-kind property if you elect to donate your art to a private non-profit foundation instead of a public charity.
Assume that you are giving your painting to a public charity[2], namely, to a museum. Assume further that the intended philanthropic gift, an early 19th Century oil painting, has a fair market value (FMV) of $70,000. Assume further that you had purchased the painting ten years before for $40,000, giving you a $30,000 long-term capital gain. Finally, assume that your Adjusted Gross Income (”AGI”) (known as the “donor’s contribution base”)[3] for the year in which the gift is being made is $100,000. In this case, the IRS does NOT allow you to deduct the painting’s $70,000 FMV against your income in the year for which you are filing your 1040 return. Instead, the Government limits the amount you may deduct in the first year to only 30% of your $100,000 contribution base. You may then deduct the difference between the gift’s $70,000 FMV and the allowed deduction of $30,000, (i.e., $40,000) over a five-year carryover period. Assuming that in each of the next five years you have the same $100,000 AGI, then you would be allowed to deduct the $30,000 excess above the allowed single-year deduction over the next five years. [4] In our example, in year two, you would be allowed to deduct an additional $30,000 against your year two income and an additional $30,000 and in year three the final $10,000 of the excess over the first year’s deduction limit. Therefore, under this scenario, your total tax-deductible non-cash philanthropic gift will be the painting’s full $70,000 FMV but spread out over three years.
However, assume that instead of having an AGI of $100,000 for all relevant years, your contribution base is only $30,000. In that event, the maximum amount that can be deducted against your income is 30% of $30,000, or $9,000. This leaves an excess of $61,000, i.e., the difference between the painting’s fair market value of $70,000 less the $9,000 deduction. If we assume that your contribution base remains flat for the next five years, you will not be able to deduct the full fair market value of the painting. Specifically, in the next five years, the donor’s maximum annual deduction will stay at $9,000, which means that over 6 years (i.e., the first donated year plus the 5 carryover years), only $54,000 of the painting’s $70,000 fair market value can be deducted, leaving $16,000 of donated value for which you as the charitable donor receives no tax benefit.
The IRS has permitted an exception to the above-stated rule, presumably for persons such as those with high income now but who expect to earn much less in subsequent years, such as retirees. For this class of taxpayer, the IRS permits the donor to deduct 50% of the donated object’s original basis, not its current fair market value. In other words, 100% of the painting’s appreciation is disallowed as part of the deduction. Consider the following example: The donor of a painting paid $60,000 for a painting that has appreciated to $70,000. Assume further that the donor’s AGI is $100,000. Under these facts, the donor may take a deduction equal the tax basis of the painting but in no event more than 50% of the donor’s AGI. In this example, the maximum year one benefit is (i.e., $50,000) and the excess between that deduction and the original $60,000 basis (i.e., $10,000) can be carried over as a deduction against income for the next five years. However, the donor in this example is not entitled to deduct the painting’s full $70,000 FMV, leaving $10,000 of donated benefits unused. However, the circumstances in which this formula results in greater tax benefits for the taxpaying philanthropist are unusual, and taxpayers rarely elect it.
A word about the five-year carryover period is in order. It’s important to point out that if you are donating property that has appreciated and want to deduct its full FMV from your tax obligation, you will be required to pay taxes on the amount of appreciation. The good news is that if you have excess deduction benefits that need to be carried over to subsequent years, the IRS still treats the amount being carried over as long-term capital property. Gains on long-term capital property are subject to the much less onerous capital gains tax rate than the ordinary income tax rate. Currently, as a result of the Tax Cuts and Jobs Act of 2017, the long-term capital gains tax rate has fallen from 28% to 20%, 15% or 0% based upon the tax payer’s AGI.[5]
Finally, if you plan to give your art to a private philanthropic foundation[6] instead of a public charity, the IRS further limits the amount you may deduct against income. Specifically, assume you have a bronze statue having a present FMV of $100,000 for which you paid $20,000 that you plan to donate to a private charitable foundation. Under this scenario, the IRS allows you to deduct only your original cost, i.e., $20,000, disallowing consideration of 100% of the statue’s $80,000 appreciation. If that limitation didn’t hurt enough, the IRS further restricts limits on writing off the $20,000 cost basis by restricting your deduction to the lesser of 20% of the tax payer’s contribution base (in this case, $20,000) or that amount equal to the excess of 30% of the taxpayer’s contribution base over the amount of charitable contributions allowed to public charities. In most cases, the lesser amount allowed will be 20% of the contribution base. In this example, the amount of the deduction is only $20,000, leaving $60,000 of appreciation that is unavailable as a tax deduction.
The top two lessons to be learned from this article are: (1) time your philanthropic giving so that it has maximum benefit against an anticipated higher or lower AGI, and (2) reconsider donating your art to a private foundation if a different public charity you want to support can use your art in a manner consistent with its charitable purpose. Understanding these rules can make the difference between benefiting from, or losing, many thousands of dollars in tax deduction benefits.
We at Arcadia Art Consultancy stand ready to help develop the best donation strategy for you and to provide USPAP qualified appraisals that are required by the IRS for any noncash gift whose FMV exceeds $5,000.
[1] This article is limited to the donation of tangible personal property such as fine art, antique cars, collections, decorative items and furniture that have been held by the donor for longer than a year and which, therefore, qualifies as long-term capital gain property. It also assumes that the use of the donated property by the donee organization is related to the purpose for which it was granted not for profit tax exemption status. Finally, and most importantly, this article is based on the assumption that the philanthropist donating his personal property has obtained a Qualified Appraisal Report from a Qualified USPAP personal property appraiser such as Arcadia Art Consultancy.
[2] For a definition of “public charity”, see I.R.C. § 170(A).
[3][3] See I.R.C. § 170(b) (H).
[4] See generally, I.R.C. § 170(b)(1)(C)
[5] See U.S.C. § 1222(4).
[6] See I.R.C. § 170(b)(1)(F).
This article is written for informational purposes only. Please consult your agents (accountants, attorneys, wealth managers, etc.).