Rule 1. A gift of long-term appreciated tangible personal property to a public charity for a related use is deductible at fair market value (FMV).
Rule 2. If the donor is a dealer, the deduction is limited to the basis.
Rule 3. Under the IRS-was-not-born-yesterday doctrine, a donor who purchases a large number of items with the intent to contribute the items after holding them for more than a year is treated as a dealer; thus, limiting the deduction to basis (or the FMV if that's lower than basis).
Rule 4. In determining FMV, bulk sales may be taken into account even if the donor is not treated as a dealer.
Rule 5. Don’t try to pull the wool over the IRS’s eyes.
Donor treated as a dealer. The IRS, in Chief Counsel Advice 201443019, gives the legal underpinnings for its position. CCA are written advice or instructions prepared by the Office of Chief Counsel and issued to field or service center employees of the IRS or Office of Chief Counsel and aren't precedents.
Code and regulation cited by the IRS. The amount of a charitable contribution of property is reduced by the amount of gain that would not be long-term capital gain if the property were sold at its FMV. Thus, if the contribution is a sale that would have result in ordinary income (such as the sale of property held by the donor primarily for sale to customers in the ordinary course of his trade or business), the deductible contribution is limited to the lesser of the donor's basis or FMV. Internal Revenue Code Section 170(e)(1); Reg. Section 1.170A-4(a).
Revenue ruling cited by the IRS—lithographic prints. The taxpayer, who wasn’t an art dealer, purchased a substantial part of the total limited edition of lithographs for a total price of $25x. After holding the prints for more than one year, he donated the prints to art museums. The FMV at the time of contribution was $100x. The IRS concluded that the taxpayer's "bulk acquisition and subsequent disposal of the prints" are substantially equivalent to the activities of a commercial art dealer, and the contributions weren't made “after a period of accumulation and enjoyment by” the donor; thus, the prints were treated as ordinary income property. The amount of the taxpayer's charitable contribution is reduced by the hypothetical ordinary income gain, and the contribution was limited to the taxpayer's cost. Rev. Rul. 79-256, 1979-2 C.B. 105, see also G.C.M. 37611 (July 25, 1978).
Comment. “After a period of accumulation and enjoyment”: Seems to me that the IRS is gilding refined gold, not to mention painting the lily. The Service needn’t throw perfume on the violet. It’s enough to characterize the donor as a dealer, or question the FMV—or both.
Revenue Ruling cited by the IRS—books. The taxpayer, who wasn't a dealer in books, purchased 100 books through a promoter at a volume discount, stored them for just over 12 months, then donated them to various charities. The Service concluded that the taxpayer's activities were "tantamount to the activity of a dealer selling books," and the books were treated as ordinary income property. Thus, if the FMV is more than the taxpayer's basis in the books, the amount of the charitable deduction must be reduced by the theoretical ordinary income gain on the property. And, if the FMV is equal to or less than the taxpayer's basis, the amount of the charitable deduction is limited to that lesser amount. Rev. Rul. 79-419, 1979-2 C.B. 107.
FMV may take bulk sales into account. Generally, under Reg. Section 1.170A-1(c)(1), the amount of a charitable contribution of property is its FMV at the time of the contribution, reduced as provided in IRC Section 170(e)(1). Reg. Section 1.170A-1(c)(2) defines FMV as the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.
Case cited by the IRS—books. The taxpayers purchased approximately 150,000 books at a substantial discount, held them for the long-term capital gain holding period, then donated them to various libraries. The Tax Court noted that the regulations under IRC Section 170 don’t specify whether a wholesale or retail market is to be used but found that the "sheer number of [donated] books . . . would require a substantial discount from the [list price]. The simultaneous marketing of all those books would substantially depress the market." Also, the Court found that a willing, knowledgeable buyer would demand and receive a substantial discount for the purchase of any of the excess inventory, particularly in the quantities donated to the various libraries. The Court held that the taxpayers' purchase of the books was an arm's-length transaction, and the FMV of the books was no more than 20 percent of the catalog list price. Skripak, 84 T.C. 285 (1985).
Case cited by the IRS—sheet music. The taxpayer, who wasn't a dealer in sheet music, purchased approximately 85,000 pieces of Yiddish and Hebrew sheet music for $10,000 and subsequently contributed nearly all of it to an IRC Section 170(c) organization. The taxpayer obtained an appraisal for his donation, valuing it at $220,120. The Court found that the existing market for this sheet music was small and concluded that "the addition of 85,000 pieces of sheet music on the public market either would depress the market for each title or, perhaps more likely, would result in many copies being unsalable for a considerable period of time." The Court held that a discount to reflect blockage was appropriate. Rimmer, T.C. Memo. 1995-215.
Compare this decision to Rev. Rul. 80-69, 1980-1 C.B. 55, stating that the best evidence of FMV depends on actual transactions, and the price at which a promoter sold gems to a taxpayer who subsequently donated the gems may be the best evidence of the maximum FMV of those gems.
Revenue Ruling cited by the IRS—bibles. The taxpayer purchased 500 copies of the Bible for $100x from a promoter who advised that $100x was a considerable discount from retail price. The promoter stored the Bibles for the taxpayer for 13 months and, at the taxpayer's direction, mailed the Bibles to a charity selected by the taxpayer. At the time the taxpayer contributed the Bibles to the charity, wholesale dealers were selling similar lots of Bibles to members of the general public at $100x. The IRS ruled that to determine FMV, reference is made to the most active and comparable marketplace at the time of the donor's contribution. Thus, the FMV of the Bibles is $100x, the price at which the Bibles were sold to the taxpayer and were still being sold to others. Rev. Rul. 80-233, 1980-2 C.B. 69.
FOR TAX HISTORY BUFFS
Charitable gifts of gems, lithographs and books have long been touted by promoters as tax shelters that make money for “donors.” For the scheme to work, a donor has to claim a charitable deduction for an amount much greater than his purchase price.
The IRS inadvertently encouraged a tax shelter in Letter Ruling 7901001 by ruling that a donor who bought books at wholesale, intending to give them to a charitable organization, got a charitable deduction for the full FMV.
Under the facts of that ruling, a book publisher sold its excess production of books to X at a distress price. The publisher continued to sell the same books to others at retail prices. X devised a “Book Purchase Participation Program,” offering to sell the books to individuals at approximately 1/3 of the publisher’s suggested retail price. The program contemplated that a purchaser would donate the books through X to a charity and receive a charitable deduction for the publisher’s retail price. Though purchasers could do whatever they liked with the books, X expected all buyers to donate their books to charity.
The IRS’s ruling distinguished those facts from Cooley, 33 T.C. 223 (1959), aff’d per curiam, 283 S.2d 945 (CA-2 1961), holding that if a taxpayer purchases items on the condition that he donate them to charity, his charitable deduction is limited to the amount he paid for the items. In the present case, however, no restrictions were placed on a buyer’s disposition of the books.
Although the IRS could have maintained that the distress price (or a price below the retail price) was the FMV, it withheld comment on the books’ value.
There are numerous cases and rulings in this area. I’ll spare you an encyclopedia. So here is just one of them:
In Rev. Rul. 79-256, (above) the IRS attempted to foil tax shelter gifts without addressing the fact question of FMV, which requires determination on a case-by-case basis. The IRS realized that by treating a donor as a dealer in the donated property, it could limit his deduction to cost basis no matter what the property’s fair market value when contributed. Here are the facts on which the IRS ruled.
Situation 1. For a number of years, Donor #1 (a lawyer) raised ornamental plants as a hobby. In 1978 and earlier years, he donated many plants to various charities after having held them long term. The plants originally cost 25x dollars; their FMV when contributed was 200x dollars.
Situation 2. Donor #2 was not a dealer in art objects. In 1977, he purchased a substantial number of limited edition lithograph prints by an established artist for a total price of 25x dollars. In 1978, after having held the prints long term, he donated them to various art museums. The total FMV of the prints when contributed was 100x dollars.
IRS ruled that both donors’ deductions were limited to basis because they had contributed ordinary income property.
[U]nder section 170(e)(1)(A) of the Code, and the corresponding regulations, the determination whether property contributed to charity is ordinary income property required that the donor be placed in the position of a seller of such property. Even though a donor is not engaged in a trade or business, the frequency and continuity of the contributions may be such as to be substantially equivalent to the activities of a dealer selling property in the ordinary course of a trade or business. Under such circumstances, the items contributed would be treated as ordinary income property.
In both Situation 1 and Situation 2, the contributions were not made after a period of accumulation and enjoyment by the taxpayers of the property contributed. On the contrary, the contributed property was produced (Situation 1) or purchased (Situation 2) in bulk and distributed to various donees. In Situation 1 the taxpayer’s continuous production and disposition of plants are the equivalent of the activities of a commercial nursery business. In Situation 2, the taxpayer’s bulk acquisition and subsequent disposal of a substantial part of the total limited edition of prints are substantially equivalent to the activities of a commercial art dealer. Therefore, under the presumed sale requirement of section 170(e)(1)(A) of the Code, the items contributed in both situations will be treated as ordinary income property.
. . . However, the treatment provided under section 170(e) does not imply that a taxpayer is engaged in a trade or business for the purposes of any other section of the Code. Furthermore, the holding of this revenue ruling is equally applicable to taxpayers who, under comparable circumstances, produce or acquire types of property other than those involved in the two situations.
Using well-established law, the IRS could have limited Donor #1's deduction to his cost basis without inventing a new “accumulation and enjoyment” test and a new “frequency and continuity of contributions” test. Even if the donor had grown and sold only one plant, he would have had ordinary income tax on his profit, and his deduction for a charitable contribution of the plant would have been limited to the plant’s cost basis. The creator and donor of a plant is analogous to an artist who creates a painting and then contributes it to charity. Because the artists’s profit on a sale would be taxed as ordinary income, his deduction for a charitable gift of the painting is limited to his cost basis in the painting.
In Situation 2, both the conclusion and reasoning are incorrect. The IRS found that even though Donor #2 wasn't engaged in a trade or business, the frequency of his contributions could be substantially equivalent to the activities of a dealer selling property in the ordinary course of a trade or business. That test is not warranted by the Code.
The IRS said it planned to apply Rev. Rul. 79-256 broadly: “Furthermore, the holding of this revenue ruling is equally applicable to taxpayers who, under comparable circumstances, produce or acquire types of property other than those involved in the two situations.” True to its word, the IRS issued Rev. Rul. 79-419 (above), using its new “dealer” theory to kill the tax shelter it had spawned in the 1979 letter ruling.
© Conrad Teitell 2015. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.
