IRS Tightens Up On Property Donations

The Alabama Tax Code contains numerous sections which incorporate Federal Code Sections by reference. In other words, if the Federal law changes, or if the regulatory guidance supporting the Federal law changes, then Alabama law automatically changes with it. One such provision in the Alabama Code is Section 40-18-15(a)(10), which allows Alabama taxpayers to deduct charitable contributions "... to the extent allowed for Federal income tax purposes" under Federal Code Section 170.

The Federal Pension Protection Act of 2006 made some key changes to the rules governing the valuation of property donated to charitable agencies. Individual taxpayers will be especially interested in the more stringent standards for used clothing and household items. The article that follows was originally written for the Aldridge, Borden & Company Internal Web Site.

The revised edition of IRS Publication 561, Determining the Value of Donated Property, was released in April, 2007. The Service revised the Publication to reflect the changes made by the Pension Protection Act of 2006 (PPA). The changes discussed fall into three main categories:

  1. The valuation of clothing or household items donated to charity,
  2. The valuation of a donated facade easement, and
  3. Increased penalties for the taxpayer and appraiser for substantial overstatement or gross overstatement of the value or adjusted basis of donated property.

Clothing and Household Items

In general, taxpayers can deduct the fair market value of clothing and household items that are donated to a qualified charitable organization such as the Salvation Army, Goodwill, or a church used clothing program. PPA stipulates that such items that are donated after August 17, 2006 must be in "good used condition, or better" in order to have any value. Pub 561 elaborates on this by saying that if such items are "too worn, out of style, or no longer useful", they may have no value.

The Publication points out that the value of used clothing is usually "far less" than the price paid for them, and that the price that would be paid in a used clothing consignment or thrift shop is an indication of value. Formulas such as a fixed percentage of original cost are not considered to produce an accurate valuation, and taxpayers should not rely on the standard "value lists" provided by Goodwill or The Salvation Army, since they also do not provide an accurate value. Finally, if a taxpayer donates any item of clothing or a household item that is not in good condition or better and is valued at more than $500, he must include a qualified appraisal of that item with his return.

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Facade Easements

Owners of historic buildings will occasionally grant an easement to a historic preservation agency such as the National Park Service. The terms of the easement might say that the owners (as well as any future owners) will not alter the exterior of the building, thereby preserving the building's historic character. Since this type of restriction is considered to reduce the value of the building because it limits the ways in which it might be used in the future, the owners are eligible for a charitable contribution equal to the difference between the value of the building before the the granting of the easement and its value after the grant, as determined by an appraisal.

According to Pub 561, easements granted after July 25, 2006 will be deductible only if:

  1. The easement preserves the entire exterior of the building and prohibits any change to the exterior of the building that is inconsistent with the exterior's historical character.
  2. The taxpayer and the organization receiving the contribution enter into a written agreement certifying that the organization is a qualified organization and that it has the resources and commitment to maintain the property as donated; and
  3. For a contribution in a tax year beginning after Aug. 17, 2006, the taxpayer includes with his return:
    • a qualified appraisal;
    • photographs of the building's entire exterior; and
    • a description of all restrictions on the building's development, such as zoning laws and restrictive covenants.

Finally, taxpayers who donate such easments after February 12, 2007 and claim a deduction of more than $10,000 must pay a $500 filing fee.

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Increased Penalties

Regulations under Section 6662, as amended by PPA, call for penalties for taxpayers who materially overstate the value or the adjusted basis of donated property, resulting in their receiving a larger deduction for the donation than they otherwise would. The same Regulations also contain penalties for appraisers who are involved in such overstatements.

According to Publication 561, a taxpayer will be liable for a penalty equal to 20% of the tax underpayment resulting from a substantial overstatement of the value or the adjusted basis of donated property. A substantial overstatement is one in which

  • The value or adjusted basis claimed on the return is 150% of the correct amount or more (200% or more for returns filed on or before August 17, 2006), and
  • The underpayment of tax resulting from the overstatement is $5,000 or more.

If the taxpayer is guilty of a gross overstatement, she will be liable for a penalty equal to 40% of the tax underpayment. A gross overstatement occurs when

  • The value or adjusted basis claimed on the return is 200% of the correct amount or more (400% for returns filed on or before August 17, 2006), and
  • The resulting underpayment of tax is $5,000 or more.

An appraiser who prepares an incorrect appraisal will be subject to a penalty under Section 6662 if

  • He knows, or should have known, that the appraisal will be used in a tax return or claim for refund, and
  • The appraisal results in either the 20% or 40% overstatement penalty discussed above.

The penalty levied on the appraiser will be the smaller of

  1. The greater of
    • 10% of the tax underpayment resulting from the overstatement, or
    • $1,000; or
  2. 125% of the fee he received for the preparation of the appraisal.

Furthermore, an appraiser may be subject to a civil penalty for aiding and abetting an understatement of tax liability if he falsely and fraudulently overstates the value of property described in a qualified appraisal attached to a Form 8283 that he signs.

This page last updated 5/28/07

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