This Insights article was contributed by Sandy Crumrine, CPA, CIA, an audit partner at Earney & Company, L.L.P.
Charity auctions are one of the most frequently used techniques to raise funds for an organization’s charitable activities, but there are a number of misconceptions associated with them.
Individuals or businesses who donate auction items generally believe they can deduct the full value of what they are donating. While this may be true in some cases, it is not always the case.
Successful bidders on auction items also generally believe they can take a charitable contribution for the full amount they pay for an item at the auction. Again, that is a misconception.
To set the record straight, we need to examine the rules applicable to both donors of auction items and successful auction bidders.
Donated Auction Items
The basis for deduction of a donated auction item depends on a number of factors. For starters, the contribution deduction for ordinary income property
is limited to the donor’s cost of the item, even though the fair market value (i.e. the normal selling price of the item) is greater. Examples of ordinary income property include inventory and works of art or literature crated by the donor.
There are additional restrictions on the contribution deduction for tangible personal property
if the property is unrelated to the organization’s exempt purpose. In such case, the allowable contribution deduction must be reduced by the amount of gain that would have been long-term capital gain had the property been sold for fair market value.
Examples of tangible personal property include artwork purchased by the donor more than one year earlier for the donor’s personal art collection.
When a donor donates depreciated property
to a charity auction, the charitable deduction is limited to the lower of fair market value of the donor’s tax basis in the property. Therefore, a charitable donation of depreciated property may result in a non-deductible loss (the difference between the higher, nondeductible donor’s basis and the lower, deductible fair market value). In this case, it would make more sense for the donor to sell the property, recognize the loss and contribute the proceeds from the sale to the charity allowing for the purchase of auction items.
are frequently contributed to charitable organizations as auction items. These items are generally associated with a donor’s profession, such as massage therapy or personal athletic training. A contribution deduction is not allowed for the donation of services.
Successful Auction Bidders
If there is any one single misconception associated with charity auctions it is that the amount paid for successfully bid items is a charitable contribution equal to the amount paid.
In fact, a charitable contribution results only if the amount paid for the item exceeds its fair market value. It does not matter how the charity obtained the property - by gift or purchase. The bidder has received value in exchange for the successful bid; therefore, the amount paid is not a gift.
However, there may be a gift element to the transaction if the amount paid exceeds the fair market value of the item.
In showing that a gift has been made, an essential element is proof that the portion of the payment claimed as a gift represents the excess of the total amount paid over the value of any consideration received in exchange.
This leads to my final point - the disclosure rules applicable to charitable beneficiaries.
Charities benefitting from charity auctions have a responsibility for proper reporting to the successful auction bidders. The IRS has reported an increasing number of instances in which the public has been erroneously advised in advertisements or solicitations that the entire amounts paid for tickets or other privileges in connection with fundraising events for charity are deductible.
Audits of returns are revealing other instances of erroneous advice and misunderstanding as to what, if any, portion of such payments is deductible in various circumstances. As a result, the IRS now requires charitable organizations that receive “quid pro quo contributions” in excess of $75 to disclose the value of the good or services provided in exchange for the payment. The disclosure must be made in any solicitation materials, and is required to be included in a receipt for payment.
To comply, charities holding auctions should tag each auction item with a good-faith estimate of the fair market value of the item. The charity should request that the donor of the item provide an estimate of the item’s market value. In addition, the receipt the organization issues to the successful bidder at the time of payment for the item should reflect both the amount paid and the estimated fair market value. The successful bidder must be informed by the charity that the amount of the deductible contribution is limited to the excess of the money paid for the item over the fair market value of the good or services provided.
This article is meant to provide an overview of the more general issues related to charity auctions but there are other factors that may come into play, depending on the type and value of the auction item, such as appraisal requirements.
When in doubt as to how to proceed for tax reporting purposes, consult a professional tax advisor.
Chad Wouters, CPA joined Earney & Company in December 2006 and became the tax partner in November 2013. With an emphasis on strategy and planning, Chad works with his clients all year to ensure the most efficient tax strategies are put into place. Earney & Company, L.L.P. is a CPA firm that handles tax compliance, consulting and planning as well as audit and other assurance services. For more information please visit www.earneynet.com or call (910) 256-9995. Chad can also be reached at [email protected].