Generally, you can deduct monetary gifts made to charity with no worries, assuming you keep the proper records. But the rules are far more complicated if you donate property instead of cash to a qualified charitable organization, especially if the property has appreciated in value. Fortunately, astute taxpayers can turn these rules to their tax advantage.
Background: One key element is the length of time you have owned the property when you donate it. If you have held the property long enough for it to qualify for long-term capital gain had you sold it—in other words, more than one year—you can deduct an amount equal to the property’s fair market value. On the other hand, if the property would not qualify for long-term capital gain treatment on a sale (i.e., owned for a year or less), your deduction is limited to your basis in the property (generally, its original cost).
Thus, this rule can change the way you give property to charity. For instance, suppose you own stock bought 10 months ago for $5,000. The stock is currently worth $7,000. If you give the stock to charity today, you can only deduct your basis in the stock, or $5,000. However, if you wait two more months to donate the stock, your deduction is increased to its fair market value, or $7,000.
In other words, you get the tax benefit of appreciation in value when you donate property held longer than one year. You are never taxed on the $2,000 appreciation in value.
There are a few other obstacles to overcome. Significantly, if you donate property that is not used to further the charity’s tax-exempt function, your deduction is limited to your basis in the property. For example, if you donate artwork to your alma mater, insist on having the school display the art in a place where students can view it and study it. That way, you can deduct the art’s fair market value, assuming you owned it for more than one year. However, if the school simply keeps the art in a storeroom, you get no tax benefit from the appreciation in value.
What happens if the property has depreciated in value? In that case, your deduction is limited to the fair market value, regardless of how long you have held the property. You can’t deduct the difference in your basis and the fair market value. Let’s say you donate a used car to charity. If you bought the car for $25,000 and it’s now worth $10,000, you may deduct $10,000 on your tax return.
Also, be aware that certain itemized deductions are reduced for high-income taxpayers. This reduction applies to deductions for charitable gifts.
Final words: Regardless of whether property has appreciated or depreciated in value, it is recommended that you obtain an independent appraisal of the property’s current worth. This is the best proof you can have if your deduction is ever challenged. The IRS requires an independent appraisal for property donations exceeding $5,000.