All Your Basis Are Belong to What You Paid (Mostly): A Quick View on Basis and Donations
Even a pandemic does not halt a hunt for deals. This Black Friday, November 27, shoppers are in a race to grab deals – except this time, mostly virtually, and the internet is keeping up with frequent updates. Next Tuesday, our communities will be in a frenzy again – this time to give – to charities that seek donations on Giving Tuesday, December 1. Just in case anyone is excited about a “sticker price” deduction for the PS5 you were lucky enough to grab at 20 percent off that you generously give away to your favorite gaming charity on Giving Tuesday, here’s a quick summary of why that more-than-you-paid-for-it deduction is about as unlikely as buying a PS5 at all now, let alone at a discount.
As an example, let’s say you purchased a useful and timely item at a steep discount on Black Friday – perhaps a large crate of toilet paper (bathroom tissue – a rare asset in 2020) at $5,000, discounted 50% from its “sticker” price of $10,000 that you decide to donate to your local charity. Can you deduct the donation and how much can you deduct?
Query 1: Was the donation to a qualified charity?
A deduction for a contribution of goods to a qualified charity, that is, a charity that is recognized as a tax-exempt (commonly referred to as a Sec. 501(c)(3)) organization may be deductible up to its fair market value. A list of qualifying charities is located on the IRS website in a searchable Publication 78 database. Note that the database is lagging behind in updates. If your desired charity is not listed, ask the organization to provide you with the EIN and a copy of its Determination Letter to verify.
Query 2: Is the donation deductible on your federal income tax return (Form 1040)?
You can deduct your donation of money or property if you itemize your deductions and the donation was made to a qualified charity. Whether or not you itemize will depend upon the standard deduction applicable to your tax filing status, and whether itemizing deduction would provide a greater benefit than using the standard deduction. Itemized deductions include charitable donations, state and local taxes paid, high medical and dental expenses (there are minimum amounts required to deduct these expenses), etc. The standard deduction for married couples filing jointly is $24,800 for 2020, for example.
Query 3: Do you deduct the purchase price of $5,000 or the sticker price of $10,000?
You would likely only be able to deduct up to the amount you actually paid for the donated asset – in this case, $5,000, which is the basis of the asset. Basis is usually the price paid for the acquisition of an asset. There are special rules that apply when you receive an asset by gift or inheritance where the basis in your hands is different (in the case of an inheritance, it is usually the fair market value on the date of the decedent’s death and in the case of a gift, the basis is the usually the original cost of the acquisition in the hands of the donor). There are also special rules on computing the adjusted basis for certain assets such as stocks where commissions or expenses may be added in to determine the basis in the asset.
In a 2018 case (Grainger, T.C. No. 27817-16), the Tax Court addressed this issue when it ruled against the enormous deductions (based on “sticker prices”) a retired grandmother claimed for her donations of clothing that she purchased at heavily discounted prices. She described her scheme as her “personal tax shelter” which the ocourt very quickly disallowed. Although a deduction for fair market value may be allowable on certain asset donations, the failure to substantiate the value as any higher than the price paid for the property donated will generally limit the donation to no more than the price originally paid for the donated asset.
Fair market value is the value that asset would sell for in the open market. Technically, the charitable donation is for the fair market value on the date of the donation. So, if you can prove that the fair market value on Giving Tuesday, when you donate the crate of toilet paper, is a different amount that what you paid for it, it may be allowable. The substantiation requirements are very specific and the presumption that the purchase price does not represent an unusual deviation from the fair market value would be difficult to overcome.
Query 4: Can you deduct the entire amount that is allowable under Query 3?
There are further limitations on the deduction– generally, donations of things (i.e. not cash), tangible or intangible, is limited to a deduction of 50/30/20 percent of your adjusted gross income (AGI) (cash donations have a temporarily increased to 60 percent of AGI) depending upon the type of organization donated to and the manner in which donated (whether for the use of the organization or to the organization). The finer details are summarized in IRS Publication 526.
Unfortunately, even if you were gifted the crate of toilet paper and you donated it to charity, you would be limited to the amount of the original purchase price because that would be the basis that carried over to you. Generally, the deduction in such situations may be limited to the lesser of fair market value or the basis, whichever is lower.
Good news is that your steeply discounted purchases may benefit from a lower sales tax – sales tax is determined under state and local law, and is generally computed on the purchase price, that is, what you actually paid for it.
While the above touches on some of the issues with charitable deductions and transfer of assets in an hopefully, light-hearted manner, the Royal Law Firm’s PLLC’s business, tax, and estate planning practices includes navigating the greater complexities of valuation and deductibility in buy/sell transactions, charitable donations, and gift transfers. Contact us to learn more.