A number of tax planning opportunities are available when gifting artwork. However, for donors who have not done their tax homework, several surprising results can occur.
Know Your Donee: Related-Use Concerns
The donor's knowing the donee is a critical component to a successful and tax-advantaged transfer of appreciated artwork. A critical step to achieving the desired result hinges on the concept of "related use." Because faltering on the related-use rule can unwind even the best tax planning, it is vital that the donor know the donee organization.
When first established, a charitable organization has to apply to the IRS for approval of its tax-exempt status. This application states the reason or purpose for the charitable organization's existence. This reason or purpose can dictate whether the donor contributing property to the charity receives a deduction equal to the fair market value (FMV) of the property or receives a deduction limited to the cost basis of the property. Specifically, Sec. 170(e)(1)(B) states that the amount of a charitable contribution of tangible personal property is reduced if the donee's use is unrelated to the purpose or function constituting the basis for its exemption under Sec. 501.
Example: A purchased a piece of artwork several years ago at a fire sale price. Over the years, the artwork's value grew substantially. If A donates the artwork to a public charity that operates with a purpose of saving endangered wildlife or if A donates it to a private charity, the deduction would be limited to the price originally paid for the artwork. On the other hand, if A donates it to an art museum that houses a number of similar artistic pieces, A would be able to deduct the full FMV of the piece.
Knowing details about the donee is critical to maximizing the charitable deduction.
Some interesting related-use IRS rulings have addressed the donation of an antique car to a university (unrelated use) and the contribution of a stamp collection to a college with engraving in the curriculum (related use) (Letter Ruling 8009027 and Letter Ruling 8208059, respectively).
In some instances, a charitable contribution of artwork can lead to income recapture if the donation to the charitable organization exceeds $5,000 and the organization disposes of the artwork within three years of the donation (Sec. 170(e)(7)). The donor can avoid this harsh penalty by requesting a specific written certification from the donee organization, under penalties of perjury, certifying either that the donee's use of the artwork was substantial and related to its exempt purpose or, if it was not substantial, its intended use has become infeasible or impossible to implement (Sec. 170(e)(7)(D)).
AGI Limitations Apply to Donor
A taxpayer's annual charitable contribution deduction is limited to a certain percentage of adjusted gross income (AGI), without regard to net operating loss deductions (referred to as the taxpayer's "contribution base") (Sec. 170(b)). The contribution base limitations fall into three broad categories: 50%, 30%, and 20% of AGI. The 20% category applies to donations of capital gain property to private foundations or other charities that are not 50% limit organizations. The value of these donations must be reduced by any ordinary gain that would have been realized if the property had been sold at FMV.
The 50% and 30% categories have additional wrinkles with their implementation. The contribution base differs depending on the type of donee organization and the type of asset contributed. Sec. 170(b)(1)(A) states that donations of non-capital gain property are subject to a 50% limitation if the donee organization is a school, hospital, church, or other 50% limit organization. Non-capital gain property donated to a non-50% limit organization is limited to a 30% contribution base.
When a taxpayer donates capital gain property, such as artwork, to a 50% limit organization (including a private operating foundation), the IRS gives the taxpayer two options. The taxpayer can use the general rule from Sec. 170(b)(1)(C)(i)—deduct the FMV of the artwork and apply the 30% limitation. Alternatively, under Sec. 170(b)(1)(C)(iii), the taxpayer can elect to use the special 30% limitation, which allows the taxpayer to deduct the tax basis of the property (forgoing the appreciation in value) and apply the 50% limitation. A contribution of appreciated capital gain property to a private operating foundation qualifies for this same treatment.
This election might be ideal for a taxpayer (1) with capital gain property that does not have a large unrealized gain, or (2) who has a lower contribution base. With either of these fact patterns, this election could maximize the charitable contribution. However, this election should be made with care since it is irrevocable.
When contributing to 50%, 30%, and 20% organizations, taxpayers must apply complex ordering rules, as described in Sec. 170(b)(1). These rules should be reviewed before completing any donation.
Don't Skimp on the Appraiser
Carefully choosing an appraiser is also key to successful charitable giving of appreciated artwork. Cutting corners on this step can cause the disallowance of the entire value of the contribution. The Pension Protection Act of 2006 (PPA), P.L. 109-280, added Sec. 170(f)(11)(E), which codified the definition of a qualified appraiser and what it means to have a qualified appraisal. The PPA changes strengthened the professional requirements that a qualified appraiser must meet, including having certifications, experience, and formal, professional-level coursework.
The PPA changes require that an appraiser be someone who regularly performs appraisals of the type of property being valued. Thus, the qualified appraiser must have some specialty in the line of property being appraised. That is, an art appraiser could be qualified to appraise a Van Gogh but not qualified to appraise ancient Egyptian pottery. By definition in Regs. Sec. 1.170A-17(b)(5), certain individuals cannot render a qualified appraisal. The list is detailed but generally excludes individuals who would have a conflict of interest in the outcome of the appraisal or who would not be considered independent with respect to the value. The appraiser must be independent of the donor and the charitable institution receiving the donated artwork. Appraisers can also be subject to civil penalties for incorrect appraisals.
Ensuring a proper valuation of the artwork is a foundational step in the overall charitable giving plan. The IRS has a long history of challenging and litigating appraisal conclusions in court. While not exempt from challenge, if prepared by a qualified appraiser and thoroughly documented with solid facts and conclusions, an appraisal can go a long way toward a sustainable contribution deduction. The PPA added details regarding the content and timing of appraisals and the professional standards, as developed by the Uniform Standards of Professional Appraisal Practice, that appraisals must meet. IRS Publication 561, Determining the Value of Donated Property, lists 11 points of information that each appraisal must contain. Specific to works of art, the appraisal must contain a complete physical description of the object, including size, subject matter, medium, name of artist, and date of creation. The cost, date, and means of acquisition; history of the item; and verification of authenticity must be included as well. Any deviation could call into question the whole appraisal.
With donations of artwork, the taxpayer often goes to great lengths to validate the amount of the deduction. A donor may want some assurance that the IRS will accept the value. For donations of an item of art appraised at $50,000 or more, a taxpayer can request a Statement of Value from the IRS. Rev. Proc. 96-15 outlines the requirements and steps for obtaining a Statement of Value, which a taxpayer can rely on for tax return purposes. The request for a Statement of Value involves a user fee and must be submitted to the IRS after the donation has been made but before filing the tax return.
While some hurdles exist when donating artwork, taxpayers who do their homework, consult with experts, and pay attention to the details can reach a successful result.
Mindy Tyson Weber is a senior director, Washington National Tax, for RSM US LLP.
For additional information about these items, contact Ms. Weber at 404-373-9605 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with RSM US LLP.