For contributions, bequests, and gifts made after Aug. 17, 2006, the Pension Protection Act of 2006 limits deductions for charitable contributions of fractional interests in tangible personal property. It also provides rules for valuing the donor's additional fractional interest contributions, and provides for recapture of the charitable deduction.In calculating deductions, the PPA requires consistent valuation of all the fractional interests in the same item (or collection of items) of property that has appreciated in value since the initial contribution.
Deduction limits
No deduction is allowed for a contribution of an undivided portion of a taxpayer's entire interest in tangible personal property unless, immediately before the contribution, all interests in the property are held by either the taxpayer alone, or by the taxpayer and the charitable donee. Thus, a taxpayer who is the sole owner of an item of tangible personal property is allowed a deduction if he contributes an undivided interest in the property to a charity.
If a taxpayer owns only a partial undivided interest in the property, she is allowed a charitable deduction for a gift of that interest to a charity that already owned the remaining undivided interest. This means that if a taxpayer who is the sole owner of an item of tangible personal property gives an undivided interest in it to a charity, he gets a charitable deduction for that gift. If the taxpayer later gives any part of his remaining undivided interest in that property to the same charity, he gets a charitable deduction for that contribution as well.
However, if the taxpayer gives part of his remaining interest to a different charity, no charitable deduction is allowed for that gift.
Example 1: Your client owns a statue. On Oct. 1, 2006, she contributed a one-third undivided interest in it to a museum, and is entitled to possession during eight months of each year. Her gift is an initial fractional contribution (see below), for which she can take a deduction in 2006. If your client contributes another undivided one-third interest to the same museum in 2009, so that she is entitled to possession during four months of each year, she will have made an additional contribution, for which she will get a deduction in that year.
The Internal Revenue Service is authorized to issue regs that would provide exceptions to the rules above if all persons holding an interest in the property make proportional contributions of an undivided part of the entire interest they hold.
Example 2: Your client owns an undivided 60 percent interest in a painting, and his sister owns an undivided 40 percent interest in the same painting. Regs issued by the service may provide that each would be able to get a charitable deduction for a contribution of part of their interests in the painting to the same charity, but only if each contributes the same percentage of their interest, e.g., your client contributes 50 percent of his 60 percent interest and his sister contributes 50 percent of her 40 percent interest.
Valuing fractional interests
The act doesn't change the rules for determining a donor's deduction for the initial contribution of a fractional interest in an item (or collection of items) of tangible personal property. The deduction continues to be based on the fair market value of the property at the time of the contribution, taking into account whether the use of the artwork will be related to the donee's exempt purpose.
However, under the act, the fair market value of any additional contribution of a fractional interest will be determined by using the lesser of the property's fair market value at the time of the initial contribution, or at the time that the additional contribution is made.
Example 3: The same facts apply as in Example 1. In 2006, when your client made her initial contribution of a one-third undivided interest in the statue, its fair market value was $6 million. Assume that when she makes an additional contribution of another one-third interest in the statue, its value has increased to $7.5 million. Because the statue's fair market value in 2006 is less than its $7.5 million fair market value in 2009, your client must use the $6 million fair market value in 2006 to determine her charitable deduction in 2009.
Thus, her deduction for the additional contribution is $2 million (one third of $6 million). Under pre-PPA law, your client's deduction for the 2009 contribution would have been based on the statue's 2009 fair market value of $7.5 million, and would have entitled her to a deduction of $2.5 million (one third of $7.5 million).
Example 4: The same facts apply as in Example 3, except that the value of the statue when the additional contribution of a one-third undivided interest is made in 2009 is $4.5 million. Your client's deduction for the contribution made in 2009 will be only $1.5 million (one third of $4.5 million), since the fair market value of the statue at the time that the additional contribution is made is less than its fair market value at the time of the initial contribution.
Rules similar to those discussed above for income tax purposes also apply for purposes of the gift tax charitable deduction and the estate tax charitable deduction. For example, if an individual makes a contribution of a fractional interest in tangible personal property during his life, and then makes an additional contribution of an interest in the same property at his death (e.g., through a bequest in his will), the fair market value of the property, for purposes of determining the allowable amount of the estate tax charitable deduction, is the lesser of the fair market value that was used for purposes of determining the income tax charitable deduction for the initial fractional contribution, or the fair market value of the property at the date of the decedent's death (or alternate valuation date, if applicable).
Deduction recapture
The PPA requires the recapture of the income (or gift) tax charitable deduction in certain circumstances. Specifically, the IRS is to provide for the recapture of any charitable deduction (plus interest) allowed for the contribution of an undivided interest of a taxpayer-donor's entire interest in property:
* In any case where the taxpayer-donor does not contribute all of the remaining interest in the property to the donee (or, if the donee is no longer in existence, to any person described in IRC § 170*) before the end of a specified period (defined below); and,
* In any case where, during the specified period, the donee hasn't had substantial physical possession of the property and used it in a use related to a purpose or function constituting the basis for the organization's exemption under IRC § 501.
The specified period starts on the date of the initial fractional contribution and ends on the earlier of the date that is 10 years after the initial fractional contribution, or the date of the taxpayer-donor's death.
In the year recapture occurs, i.e., the year that includes the end of the specified period, the taxpayer must include the amount of the disallowed deduction in income, pay income or gift tax plus interest on that, and pay an additional recapture penalty equal to 10 percent of the recaptured amount.
Bob Rywick is an executive editor at RIA, in New York, and an estate planning attorney.
