How to Make Sure Your Charitable Donation is Tax-Deductible
Key Points:
A donor should not receive a benefit of equal or greater value in exchange for a donation in order for it to be tax deductible.
The organization that a donation goes to must be considered a “qualified organization” by the Internal Revenue Service (IRS).
There are several types of contributions that a donor can make in addition to cash. The type of contribution made will determine how it should be valued for tax reporting purposes.
Have you ever given something to an organization and wondered if it would count as a tax-deductible charitable donation? And even when you do find that the donation is deductible on your tax return, do you know how to determine its value? These are two common tax planning questions we receive from clients.
Assuming you are itemizing deductions, there are several tests that a donation must pass to be tax-deductible. First, as the donor, you should not receive a benefit of equal or greater value in exchange for the donation. Second, your donation must be given to a “qualified organization.” There are also record keeping requirements.
Although the first test may seem logical and easy to pass, there are many situations when the results may not be so clear-cut. Below are some common examples of these special donation situations:
You attended a charity benefit event and the cost to attend was $200. You later receive a thank-you letter from the charity stating you received $75 in value (e.g., food and entertainment). The amount of the donation that is deductible is $125.
You were at an auction held by a charity and ended up being the highest bidder for an item. The tax-deductible amount is equal to the difference between what you paid (your bid) and the item’s estimated fair market value (FMV) that is usually provided by the charity. (Note: The difference is tax deductible only if what you paid was higher than the item’s FMV.)
You donated to a college or university, which comes with the right to receive tickets to an athletic event. Prior to 2018, you were allowed to deduct 80% of this donation. Unfortunately that deduction is no longer allowed under the new Tax Cuts and Job Act that when into effect in 2018 until 2025.
When applying the second test to donations, the Internal Revenue Service (IRS) has determined what they consider to be “qualified organizations”. (See top half of Figure 1.) If you are still unsure whether an organization is qualified, the IRS has an online search tool¹ that will allow you to look up the organization in its database.
In addition to cash or property, you may be surprised to know that there are other types of contributions that have special rules for deductibility. (See bottom half of Figure 1.) For example, money used to pay for raffle tickets is nondeductible since there is a chance of winning something that is valued higher than the cost of the ticket. Political contributions are not allowed either, as they could potentially influence legislation. On the other hand, it’s important to keep track of out-of-pocket expenses when volunteering with qualified organizations. Those expenses are considered tax-deductible.
Once you have determined that a donation is tax-deductible, there are several types of contributions that you can make, either with cash or other property. The type of contribution will determine how to value it for tax deduction purposes. (See Figure 2.)
As you can see from Figure 2, aside from donations of cash, there are several other types of donations you can make. Ordinary income property could be items like business inventory or intellectual property. Capital gain property, such as securities (e.g., stocks and bonds), personal property or real estate, are considered long-term if they have been held for more than one year. Personal property is anything that can be seen or touched, with the exception of real estate.
Most types of contributions should be valued using “fair market value” (FMV). FMV is defined as the price determined by a willing buyer and seller who both have a reasonable knowledge of the relevant facts about the asset². For example, the FMV for a publicly traded security (e.g., a stock or a bond) would be the average of the high and low price on the date the security was transferred to the charity. In the case of personal property or real estate, an appraisal or review of comparable sales is typically required to determine FMV.
Some types of contributions should be valued at their “adjusted cost basis.” Cost basis is the original purchase price of the property or security. In some cases, there are required adjustments to this amount, such as costs associated with improving the value of the asset (increases cost basis) or depreciation expenses (decreases cost basis).
In the case of donated personal property, the valuation method will depend on whether the donated property is used by the organization for their primary purpose or function (i.e., “related use”). For example, a painting donated to an art museum for display should be considered a related use donation, therefore valued at FMV. However, if the painting was donated to the American Red Cross, a public charity that intends to sell the painting (i.e., not related use), the donation should be valued at its adjusted cost basis, assuming it is less than FMV.
There are many types of donations that are tax-deductible and many others that are not. Properly valuing some of those donations for a tax deduction can be complex. If you have any questions or would like further information about any of this, please feel free to contact us.
Sources
¹IRS, Exempt Organizations
²Investopedia, Fair Market Value