New valuation rules apply to the charitable donations of vehicles.

Abstract

The rules for determining the amount of a deduction for the charitable contribution of a vehicle were recently amended by the American Jobs Creation Act of 2004. Although charitable contributions of property are generally based on fair market value, the new rules limit the amount of the deduction to the gross sales proceeds from the subsequent sale of the vehicle by the charity.

Introduction

The Internal Revenue Code (IRC) allows a deduction for charitable contributions made during the taxable year. The American Jobs Creation Act of 2004 (AJCA) made significant changes to the rules governing charitable contributions when the contributed property is a vehicle. (1) AJCA added Section 170(f)(12) to the IRC, which contains rules for determining the amount of the deduction. (2) The new section also contains reporting requirements relating to contributions of vehicles, which generally require the donor to substantiate the contribution with a contemporaneous written acknowledgment from the donee charity. In addition, AJCA added IRC Section 6720, which imposes penalties on charities for providing a fraudulent acknowledgment of a vehicle contribution. Subsequent to AJCA, the Internal Revenue Service (IRS) issued guidance which provides exceptions to the valuation rules of Section 170(f)(12).

Background

IRC Section 170 allows a deduction for charitable contributions made during the taxable year to a qualified organization. When the contribution takes the form of property, rather than cash, special rules apply. Generally, contributions of property that would normally yield long term capital gain or Section 1231 gain upon its disposition entitle donors to a deduction equal to the fair market value (FMV) of the contributed property. (3) However, when the FMV is used to value a contribution of property to a public charity such as a church, hospital, or educational organization, the maximum deduction is generally limited to 30% of an individual donor's Adjusted Gross Income for the year of the contribution.

No deduction is allowed for claimed donations of $250 or more unless it is substantiated by written documentation from a qualified donee charity indicating the cash amount or property description of donated property. In the past, the amount claimed for donated vehicles did not have to be substantiated by the donee charity. Instead, the FMV was determined by the donor who used a variety of methods, such as the vehicle's blue book value or other less reliable methods that usually inflated the contribution amount.

For property contributions of more than $500, the donor must attach Form 8283--Noncash Charitable Contributions to his tax return. The form requires specific information including the name and address of the donee charity, the date of the contribution, the donor's tax basis, the FMV of the donated property, and the method used to arrive at this value. For property contributions with a value greater than $5,000, a qualified appraisal of the donated property is generally required.

Gross Sales Proceeds Limit

Pursuant to AJCA, the deduction for donated qualified vehicles (autos, boats or airplanes) which are valued at greater than $500 is generally limited after 2004 to the amount of the gross proceeds from the subsequent sale of the vehicle by the charity. (4) This amount is often significantly less than the blue book retail value and may not be higher than the fair market value limit of Section 170(a).

Additionally, no deduction is allowed unless the contribution is substantiated by a contemporaneous written acknowledgment that meets the requirements of Section 170(f)(12)(B). An acknowledgment is contemporaneous if it is obtained within 30 days of either the contribution or the sale of the vehicle by the charity, whichever is applicable. (5) All acknowledgments of vehicle contributions must contain the following information:

* The name and taxpayer identification number of the donor;

* The vehicle identification number; and

* The date of the contribution. (6)

Additional information may also be required depending on the circumstances. For example, if the vehicle is later sold by the charity, the acknowledgment given to the donor must also indicate the following:

* The date the vehicle was sold;

* A certification that the vehicle was sold in an arm's length transaction;

* The amount of the gross proceeds from the sale; and

* A statement that the donor's deduction may not exceed the amount of the gross proceeds. (7)

This type of acknowledgment is due within 30 days of the sale, and must be attached to the donor's tax return.

Exceptions

Under limited circumstances, the gross proceeds limit--often the amount the auto is auctioned at--may not have to be used. Instead, the fair market value of the auto may be used, and provides an avenue to deduct a substantially higher amount. This will occur when the donee charity has made:

* Significant intervening use;

* Material improvement; or

* A sale or gratuitous transfer of the donated vehicle to a needy individual.

Significant Intervening Use. This exception is met if the donee charity puts the auto to significant use in its normal activities in the furtherance of the charity's mission. Incidental use is not significant, and the nature, frequency, and duration of the use of the vehicle will determine significant intervening use. Thus, a donated vehicle used to instruct trainees in vehicle repair or used to provide transportation on a regular basis will meet this standard. However, use of the vehicle merely to enhance general business skill training will not. (8) When this exception applies, the charity's acknowledgement should indicate that the charity has or intends to make significant use of the vehicle, and a detailed description and duration of such use, as well as a notation indicating that the vehicle will not be sold before completion of their intended use.

Material Improvement. If major repairs are done to the vehicle by the donee without any additional funding from the donor, the gross proceeds limitation may not apply whereby the taxpayer may use the fair market value of the donated vehicle. Thus, in situations where the donee increases the potential sales price of the donated vehicle as a result of significant improvements, taxpayers may claim a deduction equal to the fair value at the date of the contribution rather than the value at which it would have been sold in its original condition on the contribution date. Material improvement includes substantial improvement that significantly increases the value and not merely minor or cosmetic improvements such as minor paint finishes, rust proofing, dent and scratch touchups, minor interior repair, or any anti-theft device installation. (9)

Sale or Gratuitous Transfer to Needy Individual in Direct Furtherance of Donee Organization's Charitable Purpose. This condition is met if the donated vehicle is sold to a needy individual at a significantly lower price than the fair market value, or is gratuitously given to such a person in furtherance of the charity's mission of aiding the poor and underprivileged in need of transportation. Simply giving the gross proceeds to the needy upon sale of the auto will not satisfy this condition. (10)

In response to some charities who have inappropriately interpreted this sale to the needy exception to conveniently bypass the gross proceeds limitation, the IRS has declared that vehicles sold at auction are not sold at prices significantly below fair market value and do not qualify for the sale to the needy exception. (11)

Fair Market Value

When the fair market value will be used to determine the amount of the charitable contribution deduction, the taxpayer is required to substantiate this fair market value. Generally, FMV is defined as the dollar amount at which the vehicle would be sold to a willing buyer by a willing seller, assuming both have knowledge of all relevant facts and neither is required to buy or sell. (12) This value may be established by any reasonable method or through the use of an established used vehicle pricing guide, but only if the guide lists the sales price of a vehicle that is:

* of the same make, model, and year,

* in similar condition,

* sold in the same area,

* with similar options or accessories, and

* with similar warranties or guarantees.

For contributions after June 3, 2005, the dealer retail value listed in the vehicle pricing guide is not acceptable in determining the fair market value. Rather, the acceptable measure of the FMV is the private party sales price listed in the used vehicle pricing guide.

Where one of these exceptions exists, an acknowledgment must be furnished by the donee charity within 30 days of the date of the contribution. In addition to the general requirements, under these circumstances the acknowledgment must also indicate the following:

* A description of the intended significant intervening use (including duration of the use) or material improvement

* A certification that the vehicle will not be sold until such use or improvement is completed. (13)

Penalties

For those donee organizations that are required to furnish necessary acknowledgements to donors, new Section 6720 imposes penalties to those who file misleading false or fraudulent acknowledgements, and to those who knowingly fail to furnish any required acknowledgements.

Any charity which issues written acknowledgment of amounts greater than the actual auction price received will be subject to penalties under Sections 6701 and 6720. Generally, Section 6720 assesses penalties equal to the higher of (1) the product of the highest current individual tax rate (35%) times the stated sales price on the acknowledgment, or (2) the gross proceeds from the sale of the donated vehicle. For other vehicles, with a claimed value of higher than $500, which are not actually sold but where a false acknowledgement is issued by the donee charity, the penalty is the higher of (1) the product of the highest current individual tax rate (35%) times the claimed value or (2) $5000. (14)

Examples

The following examples illustrate application of the new rules:

Example 1 -- The C Charity uses a for-profit entity to solicit, process, and accept donated vehicles and act as its authorized agent. (15) Ted, an individual, donates his 2000 Toyota Camry CE sedan to the agent in October 2006. The Kelley blue book suggested retail value for a similar auto in the same condition and sold in the same area is listed at $8,400, and the Kelley blue book private party value is $5,400. The auto is auctioned in November 2006 for a gross amount of $4,000 by the for-profit agent, with a portion of the proceeds going to the agent. The agent issues Ted a written acknowledgment indicating the gross sales proceeds and date of sale within 30 days of the sale.

Since the donee clearly did not significantly use, materially improve, or sell or give the auto to a needy individual in furtherance of its charitable purpose, Ted is limited to a deduction of $4,000 for the 2006 tax year.

If, however, the charity had significantly used the auto for its charitable purpose, made material improvements to the auto that significantly increased its value, or gave or sold it for a price significantly below fair market value to a needy individual, Ted could have taken a deduction of $5,400 based on the FMV of the vehicle as determined by the private party value.

Example 2 -- Assume that in order to entice Ted to donate his auto, the agent promised to issue a written acknowledgement to Ted indicating a gross proceeds sales price equal to the blue book retail value of $8,400, instead of the actual auctioned price of $4,000. Under Section 6720, C Charity may be subject to a penalty of $4,000. The penalty is calculated as the higher of the claimed deduction times the highest individual rate (i.e., $8,400 x 35% = $2,940) or the gross proceeds ($4,000).

Example 3 -- Assume C Charity makes a false statement indicating that it will use the auto for its charitable needs for an extended period of time and Ted deducts the fair market value of $5,400. C Charity may be subject to a penalty of $5,000, the higher of the claimed deduction times the highest individual rate (i.e., $5,400 x 35% = $1,890) or the gross proceeds or $5,000.

Additional Considerations

It should be noted that trouble may arise if the donated vehicle is not sold in the year of contribution. Taxpayers are allowed a deduction only in the year of donation and only when written acknowledgment is attached to their return. Accordingly, where a donated vehicle is sold by the charity in a year subsequent to the year of donation, the taxpayer may have to file an amended return to properly claim the deduction. (16)

The IRS has released two publications to assist taxpayers: Publication 4302, A Charity's Guide to Car Donations, and Publication 4303, A Donor's Guide to Car Donations. As indicated above, a higher deduction will be available to taxpayers where any one of the three noted exceptions applies which will result in the fair market value of the donated vehicle to be utilized. Since most charities merely have their agent auction off donated vehicles, whenever a taxpayer has a fairly attractive vehicle to donate, it should be given on the condition that it will either be put to significant intervening use by the charity, materially improved, or sold or gratuitously transferred to a needy individual. This will allow for a charitable contribution deduction equal to the fair market value, which will normally be significantly higher than the gross proceeds from an auction. However, this fair market value may not be the retail value indicated in a pricing guide since it will be limited to no more than the private party value. Accordingly, a thorough search of potential charities should be made before donating your vehicle.

Endnotes

(1) American Jobs Creation Act of 2004, P.L. No. 108-357, [section] 884.

(2) Unless otherwise noted, all section references are to the Internal Revenue Code of 1986, as amended.

(3) Treas. Reg. [section] 1.170A-1(c)(1).

(4) IRC [section] 170(f)(12)(A)(ii).

(5) IRC [section] 170(f)(12)(C); Notice 2005-44, 2005-25 I.R.B. 1287, [section] 3.03.

(6) IRC [section] 170(f)(12)(B); Notice 2005-44, [section] 3.03(1).

(7) IRC [section] 170(f)(12)(B)(iii); Notice 2005-44, [section] 3.03(2).

(8) Notice 2005-44, [section] 7.01(1).

(9) Id. at [section] 7.01(2).

(10) Id. at [section][section] 7.01(3) and 3.02(3).

(11) IRS News Release, IR-2005-145, December 20, 2005.

(12) Treas. Reg. [section] 1.170A-1(c)(2).

(13) IRC [section] 170(f)(12)(B)(iv); Notice 2005-44, [section] 3.03(3).

(14) IRC [section] 6720; Notice 2005-44, [section] 7.03.

(15) Pursuant to Revenue Ruling 2002-67, a transfer to a charity's authorized agent may be treated as a transfer to the charity, who may provide contemporaneous written acknowledgements on behalf of the charity.

(16) IRS News Release, IR-2005-149, December 22, 2005.

Richard Lai, The Peter J. Tobin College of Business, St. John's University

Laura Lee Mannino, The Peter J. Tobin College of Business, St. John's University