In determining what property to contribute to a charitable organization, it is usually best to contribute appreciated property, i.e., property whose fair market value is higher than its basis in the donor's hands.This is because the appreciation in value of the property is not taxable to the donor even if the full fair market value of the property is deductible for income tax purposes. However, whether the full fair market value is deductible for income tax purposes depends on the type of property contributed.
Note the following:
1. Generally, the full fair market value of appreciated capital gain property is deductible. Appreciated capital gain property is property that would result in long-term capital gain being recognized if it were sold at the time of the contribution.
However, the full fair market value is not recognized if the contributed property is:
* Tangible personal property, unless it is contributed to a charity whose use of the property is related to its exempt purpose or function. If the property is not used for such a purpose or function (e.g., the property is sold by the donee charity), the amount of the charitable deduction is limited to the donor's basis in the property.
Example 1: Your client donates a painting with a fair market value of $100,000 to an art museum. He paid $15,000 for the painting. The museum will put the painting on public display, and has no plans to sell it. Your client may take a charitable deduction of $100,000 for his contribution of the painting.
Example 2: The same facts apply as in Example 1, except that the museum sells the painting in order to raise funds to meet operating expenses. Your client's charitable deduction for the contribution of the painting is limited to $15,000 - the amount he paid for it.
* Subject to a liability, or the donee charity assumes a liability of the donor in connection with the transaction. In such a case, the amount of the charitable deduction is reduced by the amount of the liability.
Example 3: In 2002, your client bought a statue of Julius Caesar for $200,000. She borrowed $100,000 of the purchase price from a friend. In 2005, when she still owes $50,000 of the amount she borrowed, and when the statue is worth $300,000, she contributes it to a museum that will put the statue on public display. The museum agrees to pay the $50,000 balance of her debt. She may claim a charitable deduction of $250,000 (fair market value of $300,000 less $50,000 debt assumed by the donee) for the contribution.
* A patent, copyright, trademark, trade name, trade secret, know-how, software (other than software described in Internal Revenue Code § 197 (e)(3)(A)
(i), i.e., software that is readily available for purchase by the general public, that is subject to a nonexclusive license, and that hasn't been substantially modified), and similar intellectual property. The initial charitable deduction for these types of property is limited to the donor's basis in the property.
However, the charitable deduction for each tax year ending on or after the date of the contribution is increased by the applicable percentage of qualified donee income with respect to the contribution that is properly allocable to that year. See below for a discussion of how the increase for qualified donee income is determined.
Observation: If a copyright is held by the taxpayer who created it or by a transferee whose basis is determined by reference to the creator's basis, it is not treated as a capital asset. It is therefore ordinary income property that is subject to a reduced charitable deduction under the rule immediately below, and is not eligible for the additional charitable deductions based on qualified donee income.
2. If the fair market value of appreciated capital gain property is otherwise deductible in full, and the property is contributed to a 50 percent charity, the applicable deduction ceiling is only 30 percent of the contribution base (generally adjusted gross income), unless the donor makes a special election to reduce the deduction amount.
Under this election, she can reduce the amount of her contribution by the amount that would have been long-term capital gain if the property had been sold, in return for stepping up the contribution base from 30 percent to 50 percent. This election essentially limits the amount of the deduction to the donor's basis in the property. If made, the election must cover all appreciated capital gain property contributed in the taxable year.
Observation: It usually would make sense to make the election only if the difference between the fair market value of the property and the donor's basis is comparatively small. If the fair market value exceeds 30 percent of the contribution base, the donor can carry the excess over to be deducted in the succeeding five taxable years, but would still be subject to the same 30-percent-of-contribution-base limit in those years.
Example 4: On Oct. 15, 2005, your client contributes 1,000 shares of stock in MDX Corp. with a fair market value of $201,000 to a public charity. She does not expect to make any other charitable contributions in 2005, and expects to have AGI of $400,000 in that year. She bought the shares in 2003 for $200,000.
If she makes the election to reduce the amount of her contribution to her basis in the stock, she can deduct $200,000 in 2005, but will never be able to deduct the $1,000 by which the fair market value exceeds her basis in the stock. If she doesn't make the election, she will be able to deduct only $120,000 in 2005 but will be able to carry over $81,000 to the next five succeeding taxable years until used up.
Observation: In Example 4, your client may well decide that it's better to be able to deduct $200,000 in 2005 instead of $120,000 in 2005 and $81,000 in 2006 (or later years depending on her income in 2006 and other contributions she makes that year).
Example 5: The same facts apply as in Example 4, except that your client's basis in the stock is only $130,000. If she makes the election, she can deduct $130,000 instead of $120,000 in 2005, but will never be able to deduct the $71,000 excess of the fair market value of the stock over her basis. If she doesn't make the election, she will be able to deduct $120,000 in 2005 and will be able to carry over $81,000 to be deducted in a later year.
Observation: In Example 5, you should make it clear to your client that she will be giving up $81,000 in charitable deductions in later years to increase her charitable deduction for 2005 by only $10,000.
3. If appreciated ordinary income-type property (that is, property that would have resulted in ordinary income or short-term capital gain if sold) is contributed, only the amount of the donor's basis is deductible as a charitable contribution. Appreciation in value of the property over basis is not deductible.
Increase for qualified property
If a taxpayer contributes qualified intellectual property to a charity, the charitable deduction for each taxable year of the taxpayer ending on or after the date of the contribution is increased by the applicable percentage of qualified donee income with respect to the contribution that is properly allocable to that year.
The applicable percentage is 100 percent for the year of the contribution and the next taxable year, 90 percent for the third year, 80 percent for the fourth year, and is reduced by 10 percent for each succeeding taxable year till it is only 10 percent for the 11th year. It remains at 10 percent for the 12th year, which is the last taxable year for which any additional charitable deduction is allowed.
No increase in the charitable deduction is allowed for any tax year of the donor after the 12th tax year that ends on or after the date of the qualified intellectual property contribution.
The increased deduction is allowed only to the extent that the aggregate of the increases with respect to the contribution exceeds the charitable deduction allowed without regard to the increases, i.e., the deduction claimed upon the contribution of the patent or intellectual property.
Example 6: On Oct. 15, 2005, your client, an individual who is a calendar-year taxpayer, donated qualified intellectual property to a public charity. The basis of the property in your client's hand was $25,000. She may claim a charitable deduction of $25,000 for the contribution on her 2005 tax return. Assume that the charity (also a calendar-year taxpayer) will have $2,000 of qualified donee income from the property in 2005, $15,000 in 2006, $25,000 in 2007, and $30,000 in 2008. Your client will not be entitled to an additional charitable deduction from the property until the total of the applicable percentages of the qualified donee income exceeds $25,000.
In determining when your client will be able to take an additional charitable deduction, she takes into account 100 percent of the qualified donee income for 2005 and 2006, 90 percent of the qualified donee income for 2007, and 80 percent of the qualified donee income for 2008. Thus, she takes $2,000 into account in 2005, $15,000 into account in 2006, $22,500 into account in 2007 (90 percent of $25,000), and $24,000 into account in 2008 (80 percent of $30,000).
She is not entitled to any additional charitable deduction in 2005 or 2006, since the total of the qualified donee income taken into account for those two years is only $17,000, or less than the $25,000 that she deducted with respect to the initial contribution. In 2007, she will be entitled to an additional charitable deduction of $14,500 (the excess of the total qualified donee income taken into account for 2005, 2006 and 2007 of $39,500 over $25,000).
In 2008, she will be entitled to an additional charitable contribution of $24,000, since the qualified donee income that she took into account in the three preceding taxable years was more than her deduction of $25,000 on the initial contribution. She will also be able to claim the applicable percentage of qualified donee income in each year from 2009 through 2016 as an additional charitable deduction.
Qualified donee income means any net income received by or accrued to the donee that is properly allocable to the qualified intellectual property, as opposed to the activity in which the intellectual property is used.
