If you itemize deductions on your annual U.S. income tax return, you can claim a deduction for charitable contributions. When you donate property, you will need to assign a value in order to determine how much you can deduct. There are certain tax rules and guidelines to follow in determining that value.
Fair Market Value
Fair market value is a common measure of the amount that can be deducted. For income tax purposes, fair market value is “the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts”. In determining fair market value, all factors that affect the value are relevant and must be taken into consideration. These factors include the cost of the item, the selling prices of comparable items, replacement cost, and the opinions of experts.
Fair market value also depends on desirability, use, and scarcity of the item. For example, an item of used furniture may be out of style, and in poor condition, and may have very little value. On the other hand, another item of furniture may be considered an antique, with a very high value. There is no single formula or method for determining fair market value, and all the facts and circumstances must be taken into consideration.
The cost of the item you donate may be a good indication of its fair market value if you purchased the item close to the valuation date in an “arm’s length” transaction in an open market, and the market value has not changed between the time you purchased the item and the valuation date (when you donate the item). The best evidence of any change in the market value is based on actual transactions that have taken place for the same or similar items in the market.
If there were any conditions that applied when you purchased the item, such as restrictions, covenants, or understandings, that limit what can be done with the property, and that therefore influenced the price, these conditions should be taken into consideration in determining the fair market value.
The rate of increase or decrease in an item’s value is generally assumed to be at a reasonable rate, unless you can demonstrate that there were unusual circumstances. General price trends, costs of materials, commodity prices, and bidding prices at auctions are some of the indices that can be considered.
Sales of Comparable Properties
The sales prices of other properties that are similar or comparable to the property you donate can be important in determining fair market value. The degree of influence these sales prices have on the fair market value of the donated property depends on the degree of similarity of the property, the timing of the sale (whether it was close to the valuation date), whether the sale was an arm’s length transaction, and the conditions prevalent in the market at the time of the sale (whether selling prices were unusually high or low).
Replacement cost as an indicator of fair market value depends on the supply and demand for the donated property. In order to use replacement cost as the value, there must be a reasonable relationship between the replacement cost and the going price of the property in the market.
If you donate used property, its “replacement cost new” may be a starting point, from which depreciation and obsolescence can be subtracted for the period you held the property, in order to determine its current fair market value. You should be able to demonstrate how you determined the replacement cost new, and the relationship between the depreciated value and the fair market value.
The weight of expert opinions in determining fair market value will depend on the expert’s knowledge and competence, and the thoroughness of the expert’s appraisal. The opinion must be supported by facts and experience.
Past and Future Events
The fair market value of donated property must be based on facts and circumstances that are presently known or that can be reasonably expected. You cannot base the value on unexpected future events that could occur after you donate the property, and that may increase its value.
You cannot rely too heavily on past events either. For example, if you donate property that generated significant earnings for a period of time, that period may not necessarily represent the current income-generating capacity of the property. It may be more relevant to evaluate the trend in the property’s income generation up until the valuation date.
Valuation of Different Types of Property
Based on the above discussion, different factors and criteria will enter into the determination of fair market value, depending on the type of property. There are guidelines that can be followed, as well as specific rules in certain cases, regarding the documentation you will need to support the amount of the deduction you claim. These rules are generally based on the amount of the deduction and the type of property.
Household and Personal Items
The fair market value of used household or personal items you donate is generally much less than the price you paid when those items were new. You should generally use the price that the item would sell for at a garage sale, flea market, or in a thrift store. The Salvation Army has a useful valuation guide for many of these items, including used appliances and clothing, on its website at www.salvationarmyusa.org.
Jewelry, Paintings, Antiques, and Objects of Art
The fair market value of jewelry and gems, due to their specialized nature, will almost always need to be determined by a jewelry appraiser. A deduction of $5,000 or more for the donation of a painting, antique, or work of art, must be supported by a written appraisal from a qualified and reputable source. If you claim a deduction for the donation of a work of art valued at more than $20,000, you must attach a complete copy of a signed appraisal to your tax return. For individual items valued at $20,000 or more, you may also be required to provide a photograph of the item.
Some of the most common donations of hobby collections include stamps and coins, books, manuscripts, autographs, sports and other memorabilia. The criteria to be applied in determining the fair market value will depend on the overall value of the collection. If the value is significant, an appraisal will most likely be needed. In other cases, you may be able to establish the value by consulting reference material oriented toward the type of collection being donated. This could include catalogs, dealers’ price lists, and specialized hobby periodicals.
Cars, Boats, and Aircraft
The fair market value of a car that you donate will depend on the year, make, model, installed equipment, and general mechanical condition. While for tax purposes, the fair market value is not necessarily the same as the “Blue Book” value, you may be able to use the blue book value as a guide in determining the fair market value. You can look up blue book values in the “Kelly Blue Book” website at www.kbb.com. Prices you find in Internet sites, including bids in auction sites, may also be useful in determining the fair market value.
The American Jobs Creation Act of 2004 changed the rules for the amount you can deduct for the donation of motor vehicles, boats, and planes after December 31, 2004. After that date, if the claimed value is over $500, the amount you can deduct depends on what the charitable organization does with the vehicle, boat, or plane:
1. If the charity sells the vehicle, without any significant intervening use or material improvement, your deduction is limited to the gross proceeds from the sale.
2. If the charity intends to make significant intervening use, or materially improve the vehicle, your deduction is the vehicle’s fair market value at the time of the donation.
You will need to get a written acknowledgement from the charitable organization and attach it to your tax return. This acknowledgement must include your name and taxpayer identification number, the vehicle identification number, and a statement indicating what the charity intends to do with the vehicle. This statement must certify one of the following:
Ã?Â· The vehicle was sold in an arm’s length transaction. In this case it must indicate the gross proceeds from the sale.
Ã?Â· The charity intends to use the vehicle. The statement must indicate the intended use, the duration of that use, and an affirmation that it will not sell the vehicle before completion of the intended use.
Ã?Â· The charity intends to make a material improvement to the vehicle. The statement must indicate what improvement the charity intends to make, and that the vehicle will not be sold before the improvement is completed.
You must obtain this acknowledgement within 30 days from the date of sale, if the vehicle is sold, or within 30 days from the date of the contribution, if the charity intends to use the vehicle or make material improvements.
Where there is an active securities market, such as a stock exchange or over-the-counter market, the fair market value of stocks, bonds, or other securities would be the average of the highest and lowest selling prices on the valuation date.
If there were no sales on the valuation date, you would take the average of the highest and lowest selling prices on the nearest date both before and after the valuation date, and then weight these averages in inverse order based on the number of trading days between the selling date and the valuation date. For example, if you donate stock that was not selling on the valuation date, and:
Ã?Â· The stock traded 3 days before you donated the stock, at an average price of $4, and
Ã?Â· The stock traded 2 days after you donated the stock, at an average price of $6, then
Ã?Â· The value assigned to the stock would be: (($4 x 2 days) + ($6 x 3 days)) / 5 days = $5.20
If the securities are traded on more than one exchange, their value is determined based on the prices of the exchange on which they are principally dealt.
If there were no sales within a reasonable period before or after the valuation date, the fair market value of the donated securities is the average price between the bona fide bid and asked prices on the valuation date.
If prices are not available, or if you are donating shares in a closely-held corporation, you would need to consider various different factors in determining their fair market value. For bonds, you would consider the soundness of the debt obligation, the interest yield, and the date of maturity, among others. For stock you would consider the company’s net worth, potential future earning power, dividend-paying capacity, the goodwill of the business, the general economic outlook for the company’s industry, its management, and the value of stock of companies engaged in a similar business. You should request any necessary assistance in determining the company’s value from accountants, appraisers, engineers, and other technical experts as necessary, and you should keep all the financial records, reports, and other information used in determining the fair market value.
Interest In A Business
Determining the fair market value of the donation of an interest in a business would be similar to determining the value of shares in a closely-held company. The fair market value would generally be what a willing buyer would pay a willing seller for that interest. Factors to be taken into consideration include the fair market value of the assets in the business, the earning capacity of the business, based on past and current results, and the business’s goodwill. Reports and appraisals should be obtained from technical experts, as applicable. CPA firms and legal firms can help with business valuations. There are also organizations and associations of appraisers and valuation analysts on the Internet that can provide more information or refer you to qualified experts.
Donations of real property normally require a professional appraiser to determine the fair market. The appraisal report should include a complete description of the property, physical features and condition, the use that is being made of the property, zoning restrictions and permitted uses, and the potential for other types of use.
There are three main approaches that are generally used for appraising real estate:
1. Comparable sales
2. Capitalization of income
3. Replacement cost new or reproduction cost minus observed depreciation
Under this method, the donated property is compared with other similar properties that have been sold. The selling prices of these other properties are then adjusted for differences in market value since the date of sale, and differences in the size, location and condition of the properties, to determine the estimated fair market value of the donated property. Only the properties with the least amount of adjustments should be taken into consideration.
The appraiser should document each adjustment, and the appraisal should include the names of the buyers and sellers of the comparable properties, the deed book and page on which the sales are recorded, the date of sale and the price, a description of the property, the amount and the terms of any mortgages on the properties, property surveys, the tax assessed value of the properties, and the fair market value of each property according to the appraiser.
Capitalization of Income
Under this method, the property’s fair market value is based on future earnings from the property. Future net income is capitalized at a rate that would represent a fair return on the investment, depending on the risks and other factors involved.
This method generally sets the upper limit for the fair market value of the property, especially during periods of rising prices, and is normally used in combination with one of the other methods, to corroborate the fair market value determined. For improved realty, the land and buildings or attachments must be valued separately.
The replacement cost takes into account the types of materials, level of workmanship, and the square feet of constructed space. The cost includes materials, labor, overhead and profit. Once this replacement cost is determined, it must be adjusted for factors that apply to the property that is actually being donated, such as physical deterioration of the building, and functional or economic obsolescence.
According to the American Jobs Creation Act of 2004, the initial deduction for donations of patents or other intellectual property, such as copyrights, trademarks, software, and similar property, is limited to the donor’s basis in the property (what the donor spent to create the property), or the fair market value, whichever is lower. Subsequent charitable deductions can be taken for up to 12 years, based on a percentage of the income the charitable organization receives from the property. The percentage starts at 100% the first year and is gradually reduced to 10% in the twelfth year. In order to qualify for the additional deductions, the donor has to notify the charitable organization, at the time of the donation, of the donor’s intention to take the additional deductions.
If you donate property and claim a tax deduction of $5,000 or less, you generally do not need an appraisal. You can get an appraisal if you need one to determine the value of the donated property, but you will generally not be required to have an appraisal for tax purposes. The fees you pay to get an appraisal are deductible as an itemized miscellaneous deduction on Schedule A, subject to the 2% of adjusted gross income limit.
If you are claiming a charitable donation deduction of more than $5,000 for a single item or a group of similar items, you must get a qualified appraisal and attach Form 8283, Noncash Charitable Contributions, to your tax return.
There are certain exceptions, and you do not need to have an appraisal for:
Ã?Â· Non-publicly traded stock with a value of $10,000 or less,
Ã?Â· Certain publicly traded securities,
Ã?Â· A car, boat, or aircraft donated after December 31, 2004, if your deduction is for the gross proceeds from the sale by the receiving charitable organization,
Ã?Â· Qualified intellectual property, such as patents and copyrights, donated after June 3, 2004,
Ã?Â· Inventory or stock in trade donated after June 3, 2004.
Even though you do not need an appraisal for the kinds of donations that qualify as exceptions, you will still need to complete and file Form 8283, except in the case of certain publicly traded securities, as follows.
You do not need an appraisal, and you do not have to file Form 8283 for donations of publicly traded securities that are:
Ã?Â· Listed on a stock exchange, with quotations published daily,
Ã?Â· Regularly traded in national or regional over-the-counter markets, also with quotations published daily, or
Ã?Â· Shares of open-end investment companies, such as mutual funds, if quotations are published daily in a newspaper with national circulation.
IRS Review of Appraisals
The Internal Revenue Service is not bound by the opinion of a qualified appraiser. If the IRS reviews your tax return, it may accept the amount of your charitable deduction based on the appraised value of the property, or it may make its own determination of the property’s fair market value. The IRS can review appraisals, and may refer the matter to a specialist appraiser. But it is your responsibility to adequately support the fair market value of the donated property as claimed on your return.