Thursday November 30, 2023
Article of the Month
Substantiation of Charitable Gifts of Art, Part Two
Donating a work of art to a charitable organization can be a meaningful way to align an individual's passion for art and culture with their philanthropic goals. Charitable gifts of art can offer substantial tax advantages provided donors and their professional advisors understand the federal regulations governing these types of charitable gifts.
The Internal Revenue Service (IRS) requires donors who claim charitable income tax deductions to substantiate the value of their charitable contributions. Additionally, charitable gifts of noncash assets valued above a certain threshold require donors to obtain a qualified appraisal of the asset for substantiation purposes. The Service's substantiation rules are strict. If these rules are not closely followed, a donor may lose his or her entire charitable deduction. There are several factors that may impact a donor's charitable deduction and it is important for advisors to identify and elaborate on these factors and assist donors in navigating through the process of substantiating charitable gifts of art to meet the Service's requirements.
This article will cover substantiation rules including qualified appraisal requirements, the role of the Commissioner's Art Advisory Panel, a discussion of gifts of partial interests in art and potential scams related to art donations. Part One of this series discussed related and unrelated uses of art and the donor's classification as an investor or dealer for purposes of deductibility. By understanding the rules and regulations surrounding charitable gifts of art, advisors can help ensure that their clients properly and accurately deduct their charitable donations.
Valuation and Substantiation Requirements
In addition to related use requirements and the classification of a donor as a dealer or investor, certain substantiation requirements must be met in order to claim an income tax deduction. When a donor gifts noncash property above a certain threshold value, the IRS requires additional documentation of the asset's fair market value (FMV) to calculate a charitable tax deduction.
The IRS defines the term "art" to include paintings, sculptures, watercolors, prints, drawings, ceramics, antique furniture, decorative arts, textiles, carpets, silver, rare manuscripts, historical memorabilia and other similar objects. Rev. Proc. 96-15. The value of the noncash assets will dictate which requirements must be met. The value must be aggregated for items of a similar category or type. In cases where items of a similar type collectively exceed $5,000 in value, the appraiser will appraise the items collectively. A similar item of property is defined as "property of the same generic category or type." The Service provides examples of category groups in Reg. 1.170A-13(c)(7)(iii). Separate appraisal summaries will be required for different categories of property and for each donee of the property. Reg. 1.170A-13(c)(3)(iv).
A donor who makes a noncash asset gift valued at less than $250 must obtain a receipt as substantiation for the charitable gift. The receipt must contain the name and address of the charitable organization and the date of the contribution. The receipt must provide a sufficiently detailed description of the contributed property so that a person not "generally familiar" with the type of property could ascertain that the property described is the contributed property. Reg. 1.170A -16(a)(1).
For gifts of noncash property valued in excess of $250 but not more than $500, the donor is required to obtain a receipt plus a contemporaneous written acknowledgment that complies with Reg. 1.170A-13(f) from the charity if the donor claims a charitable deduction. Reg. 1.170A-16(b). The contemporaneous written acknowledgment must include a description of the property and an estimate of any goods or services provided, excluding any intangible religious benefits.
The document is considered contemporaneous if it is obtained on or before the earlier of the date the donor files the original tax return for the year in which the contribution was made or the due date, including any extensions, for filing the original tax return for the year in which the contribution was made. Reg. 1.170A-13(f)(3). Noncash charitable contributions in excess of $500 but no more than $5,000 must obtain the same documentation as gifts valued over $250 and also requires filing Form 8283, Section A, which includes the description of the property. Reg. 1.170A-16(c)(2).
Qualified Appraisal and Appraiser
If the value of the property exceeds $5,000, donors are required to provide additional substantiation proof. Donors must comply with all documentation necessary for gifts valued over $250, with the additional requirement of an appraisal of the noncash asset, as well as a completed Form 8283, Section B. Reg. 1.170A-16(d)(1)(ii) and (iii). The appraisal must be completed by a qualified individual who holds himself or herself out to the public as an appraiser of the type of property to be appraised.
A qualified appraiser must meet the education and experience requirements. There are two ways to do so. The first is to have completed college or professional-level coursework relevant to the property being valued and have at least two years of experience in the trade or business of buying, selling, or valuing the type of property being valued. Under Reg. 1.170A-17(b)(2)(ii), the coursework must be obtained from one of three sources: a professional or college-level educational organization, a generally recognized trade or appraiser organization or an employee apprenticeship or educational program similar to the educational options above.
The alternate way to fulfill the education and experience requirements is to hold an appraisal designation from a generally recognized professional appraiser organization for the type of property that is to be valued. Reg. 1.170A-17(b)(2)(i)(A). This designation must be obtained from a generally recognized professional appraiser organization and the individual must earn the designation through demonstrated competency. Reg. 1.170A-17(b)(2)(iii). The appraisal must fully describe the appraiser's qualifying education and experience and represent the qualifications to make appraisals of the type of property being valued. The qualified appraiser must regularly prepare appraisals for which they are paid and must not be an excluded individual under applicable IRS regulations. The appraiser must also complete Form 8283, Section B Declaration of Appraiser section. IRS Pub. 561.
If the value of the donated artwork totals $20,000 or more, the donor must attach a complete copy of the signed appraisal to their return along with Form 8283. The donor must also provide either an 8x10 color photo or a 4x5 color transparency of the donated property. Advisors should emphasize to donors the potential consequences of not following substantiation rules closely, including denied deductions and penalties and interest.
ExampleSimilar property to Single Nonprofit
Eliza was an avid art enthusiast and over time became quite the art collector with various beautiful paintings proudly displayed in her home. She decided it was the right time to donate an impressionist art painting to a local museum. She had owned the painting for over a year, valued at approximately $4,500. Later that same year, she decided to contribute a long-term held realist painting valued at approximately $3,700 to the local museum. As an end of the year campaign, Eliza wanted to donate a photograph collection she purchased some time ago, valued at approximately $7,000.
Eliza knew based on the projected value of the photography gift she would need to obtain a qualified appraisal, but her advisor informed her of the need for two qualified appraisals. One appraisal was to value the impressionist and realist art collections because as a group the value exceeds the $5,000 threshold. The other appraisal was for the photographs. The appraisal of the paintings as a group satisfied the Service's definition of "similar items of property." Reg. 1.170A-13(c)(7)(iii). The photographs are not the "same generic category or type," which is why she was required to obtain a separate appraisal for that donation. Because her gifts are all to the same organization, she is able to attach a single appraisal summary for the paintings as a similar group but will need a separate appraisal summary for the photographs.
Example Similar property to Multiple Nonprofits
Donald, a passionate art connoisseur with a background in art studies and a diverse collection of rare pieces, was eager to contribute to the preservation of historical and cultural heritage. He decided to donate two items, the first was a pre-revolutionary art sculpture and the second was a statuette of a renowned general from the same historical era. Donald decided he would donate these pieces to two different organizations. The larger sculpture was valued at approximately $3,700 and was gifted to a nonprofit organization specializing in historical memorabilia, particularly focusing on documenting America's rich political and cultural heritage. The statuette was donated to a local museum known for its commitment to showcasing the history and culture of the area. The statuette was valued at $2,300.
Later that same year, Donald donated a rare coin collection that he had curated for over a year to a nonprofit dedicated to the study and collection of coins and other forms of numismatic items. The estimated value of the coin collection was $5,500. Recognizing that his coin collection exceeded the $5,000 threshold, Donald knew he would need to obtain a qualified appraisal. However, his advisor also informed him that he would need qualified appraisals for both the sculpture and the statuette because together, the sculpture and statuette as a group satisfied the Service's definition of "similar items of property" and exceeded the $5,000 threshold. Consequently, Donald is required to obtain qualified appraisals for the sculpture and statuette. Because Donald's gifts are being donated to three different organizations, Donald must attach three separate appraisal summaries to his return.
Statement of Value
For works of art appraised at $50,000 or more, donors may obtain a Statement of Value (SOV) from the IRS for advance review of art valuation prior to filing the tax return on which the deduction is claimed. The SOV establishes the value of art gifts for income, gift and estate tax purposes. The taxpayer must request the SOV after making the charitable contribution but before filing a tax return itemizing the charitable deduction. The 2023 fee schedule for obtaining the SOV is $7,500 for one to three items and $400 for each additional item. Rev. Proc. 96-15. The request must also include a copy of the qualified appraisal of the item, a completed Form 8283, Section B and the address of the IRS district office that has examination responsibility for the taxpayer's return.
Commissioner's Art Advisory Panel
Items of art with a value of $50,000 or more may also be referred to the IRS Art Appraisal Services for review by the Commissioner's Art Advisory Panel (Panel). In 1968, the IRS created the Commissioner's Art Advisory Panel to provide guidelines for determining the fair market value of artwork. Valuation standards had been a long-standing issue given that the uniqueness of each piece of artwork made it difficult to determine the fair market value. To help create an objective standard of art valuation that promoted fairness and consistency across the board, the Panel was established. The Panel, consisting of art experts including museum directors, curators, art scholars and dealers, reviews appraisals of artwork valued at $50,000 or more that are submitted on a federal tax return. Their primary role is to provide advice and make recommendations to the IRS Art Appraisal Services unit. However, the Panel's recommendations are solely advisory. The Art Appraisal Services unit assesses the Panel's recommendations and is not obligated to adopt the guidance.
Partial Interests in Art
Generally, there is no charitable deduction for a gift of less than a taxpayer's entire interest in property. Sec. 170(f)(3)(A). However, there are several exceptions to this rule. The primary consideration hinges on whether there has been a present gift of the art object.
Gifts of Future Interest
Charitable deductions are not permissible for gifts of a future interest. A future interest includes "situations in which a donor purports to give tangible personal property to a charitable organization, but has an understanding, arrangement, agreement, etc., whether written or oral, with the charitable organization which has the effect of reserving to, or retaining in, such donor a right to the use, possession, or enjoyment of the property." Reg. 1.170A-5(a)(4). According to the "intervening interest" rule under Sec. 170(a)(3), if the artwork is encumbered by a loan or other restriction that prevents the charity from having complete or substantial control or ownership of the art, a charitable deduction is not available until the restriction is lifted. This intervening interest rule is applicable to art gifts made to a charitable remainder unitrust, meaning no charitable deduction is permitted until the trustee has sold the artwork.
ExampleFuture Interest in ArtGifts of Undivided, Fractional Interests
Carol owns a collection of paintings by famous artists. Carol wants to allow others to enjoy her famous painting collection at a local art museum, but wants the paintings returned after the museum's showcase has concluded. The museum has agreed to the terms and Carol agrees to lend the paintings to the museum periodically for display purposes. Since this is a loan and Carol has not relinquished control, there is no current charitable income tax deduction. Carol retains all ownership rights over the paintings and has not made a charitable donation of the paintings.
Gifts of an undivided interest in artwork are deductible. Reg. 1.170A-7(b)(1). Deductions for charitable contributions of fractional interests are permitted only when, immediately before the contribution, all interests in the item are owned by the donor or the donor and the donee charity. Sec. 170(o)(1)(A). If the interest being contributed is not of the undivided asset, it will not be deductible.
Example Gift of Undivided InterestGifts of fractional interests in art and other tangible personal property are generally deductible. Reg. 1.170A-5(a)(2). The amount of a donor's charitable deduction for the initial donation of a fractional interest in tangible personal property is based on the fair market value of the artwork at the time of the contribution of the fractional interest. Sec.170(o)(3). If several fractional gifts from the same tangible personal property asset(s) are made over time, the deductions from additional contributions will be based on the lesser of the initial asset fractional value or the fractional value at the time of the additional contribution. Sec. 170(o)(2)(A). This valuation method applies to income, gift and estate taxes. All fractional gifts must be completed within 10 years or the donor's death, whichever is earlier. Sec. 170(o)(3)(A)(i).
Robert donated a 10% undivided interest in a collection of art to a nonprofit art institute. In the second year, he gave another 10% undivided interest in the collection of art. In the third year, Robert transferred the remaining 80% undivided interest in the collection's pieces. Because the art institute was given possession and control of the artwork for a portion of each year appropriate to its interest, and then received the remaining interest, each year the gifts qualified as a gift of an undivided portion of the donor's interest. Robert obtained the appropriate qualified appraisal each year for the contributions. Thus, a charitable deduction is permitted. In the early years, the charitable deduction may be discounted due to minority ownership.
ExampleGift of Fractional InterestAdditionally, the nonprofit must take substantial physical possession or make use of the property for an exempt purpose within one year of the initial gift or within one year of any additional gifts. If these tests are not met, charitable income and gift tax deductions for all previous contributions of interest in the item will be recaptured with interest. If deductions are recaptured, there is an additional penalty tax equal to 10% of the recapture amount. Sec.170(o)(3)(B).
Laura, a generous donor, decides to donate a one-fifth or 20% undivided share in her long-term appreciated painting, valued at $1,000,000, to a charitable organization dedicated to advancing and promoting arts and arts education across the nation. Because this gift is for a related use and is also a capital asset, her charitable deduction will be $200,000, the FMV of the artwork at the time of the contribution of the fractional interest (20% of $1,000,000). Laura decides that for the next four years, she will continue to donate an undivided one-fifth interest in the painting, until year 5 when the charity has full ownership of the painting. During this time, the painting continues to appreciate in value. In Year 2, the painting is worth $1,200,000, in Year 3, it is valued at $1,400,000, in Year 4, it reaches $1,600,000 and by Year 5, it is appraised at $1,800,000. Because the deductible amount for additional contributions is limited to the lesser of the FMV for the initial fractional contribution or the FMV of the item at the time of the additional (and subsequent) contributions, Laura will be limited to the $200,000 deduction for each of the 5 years based on the initial fractional interest contribution.
Multiple Ownerships in Art
In cases where there are multiple owners of tangible personal property, gifts of fractional interests are permissible if all persons who hold an interest in the item make proportional contributions of that person's interest to the donee charity. Sec.170(o)(1)(B). Future gifts would need to be made in the same percentages to be eligible for a charitable deduction.
ExampleGift of Fractional Interest with Multiple OwnersTime Division for Artwork
Alice and Barry are siblings and own a painting together. Alice owns an undivided 40% interest and Barry owns an undivided 60% interest in the same painting. Alice makes a 50% contribution of her interest in the painting and additionally, Barry makes a 50% contribution of his interest in the artwork. Here, a charitable deduction is permissible since each owner made a proportionally equal contribution of their undivided fractional interests to the same charity. Alice and Barry plan to gift their remaining combined 50% interest to the nonprofit in the next year.
It is also possible to transfer artwork and divide ownership into periods of weeks or months. For example, the donor may transfer the right to own and display art to an art museum for a portion of each year proportionate to its interest. Reg. 1.170A-7(b)(1)(i). The charitable deduction will be based on the percentage of time for the year that the artwork is possessed by the charity.
ExampleTimeshare Gift of Art
Leslie owns a valuable painting and plans to travel extensively, especially during the winter months in the coming years. She would like to retain ownership of the painting for five months of each year. She transfers the ownership of the painting to the art museum for the remaining seven months each year. Leslie will receive a charitable deduction for 7/12 of the value of the painting. Going forward, the charity and Leslie have joint ownership based on their respective time division for the artwork.
Art Donation Scams
While art can be a great asset for charitable donations, it is crucial for advisors to inform donors about potential scams related to art overvaluation and inappropriate art deductions. In particular, advisors should raise red flags for donors when they encounter solicitations from promoters who encourage high-income individuals to purchase various types of art at "discounted" prices, while assuring the taxpayer that the art will appreciate in excess of the purchase price. The promoters often include additional services like storage, shipping and arranging the art appraisal and donation, with the art never coming into the physical possession of the taxpayer. Promoters make bold claims about the art's value being significantly higher than the purchase price. The objective is to persuade donors to donate the art after a year (making it a long-term capital gain asset) and claim a deduction for an inflated fair market value, far exceeding the original purchase price.
Advisors should caution donors when it comes to purchasing multiple works of art by the same artists. Advisors should encourage donors to seek a second opinion as to the market value of the art; the scams provide artwork with little to no market value beyond what the promoter advertises. Another red flag to be aware of includes situations where the taxpayer is guaranteed a specific charitable deduction amount. Additionally, advisors should caution donors about using appraisers lined up by the promoter. In many cases, these appraisers may not be qualified appraisers and may neglect essential required information regarding the artwork such as the art's rarity, age, quality, condition, purchase price and more. Donors stand to lose the charitable deduction and incur penalties and interest if found to be a participant in a fraudulent scheme.
Donating art can be a powerful and meaningful way of supporting charitable causes. However, it is essential for both donors and their advisors to be well-versed with the laws and regulations governing charitable gifts of artwork. Advisors play a critical role in educating and guiding donors through this process. Advisors should emphasize the importance of adhering to substantiation requirements, shed light on the intricate rules governing fractional gifts of art and alert donors to common signs involving art-related scams. A knowledgeable advisor can help donors navigate these treacherous waters and help donors make informed decisions about their charitable contributions. With this expertise, donors can maximize the impact of their charitable contributions.
Published November 1, 2023