Properly donations: tax changes may be coming.

If your organization relies on donations of property for some of its support, you need to be watching developments in Congress very carefully. Last year, Congress rewrote the rules for donations of used vehicles and intangible property. Now, members of Congress are considering further restrictions as a way to generate revenue to offset other tax changes.

The changes, which have a reasonably good chance of passage at the time this is written, could dramatically reduce the tax benefits your donors will receive for most property (non-cash) donations other than marketable securities.

Background

For some time now, Sens. Charles Grassley, R-Iowa, and Max Baucus, D-Mont., the chair and ranking minority member of the Senate Finance Committee respectively, have been considering tax legislation, including reforms of tax-exempt organizations. In early 2004, they asked the Joint Committee on Taxation (JCT) to review the tax code and provide possible legislative changes to reduce the "tax gap." This is the difference between the taxes due if everyone paid every dollar owed under a fair tax system and what is collected now.

The JCT report, released this past January 27, contained more than 400 pages of possible tax changes. It included more than 130 pages of changes for taxation of tax-exempt organizations. The changes contemplated by the JCT cover a wide range of possibilities. But the changes that could have the widest effect are limitations on deductions for non-cash donations.

Clothing and household items

Currently, donors generally can deduct the fair market value of used clothing and household items. Technically, if your organization sells the property after receiving it, the donor's deduction cannot exceed the tax basis of the property. However, most personal items have a tax basis equal to original cost, which is usually substantially higher than its fair market value when donated. So this limitation rule has no impact.

If a donor makes more than $500 of property donations in one year, the donor is required to list the donations on Form 8283, which is filed with the donor's Form 1040. The IRS receives many thousands of these forms each year and is unable to determine if the value claimed is excessive by reviewing the information contained on the form.

Donors do not have to attach lists of donated items, although donors should have them if questioned by the IRS. Thus, the IRS doesn't know if a claimed $300 deduction includes one item or 50. This has led to a perception that there is widespread abuse of this provision, similar to the perception that led to the changes in the rules for vehicle donations last year.

The JCT recognizes that this is an area that donors can easily abuse by deliberately overvaluing donated items. Therefore, it has proposed that donors can only deduct donations of all clothing and household items up to a maximum of $500 per year. There will be no carryover for excess donations. Household items include furniture, furnishings, electronics, appliances, linens and similar items. Food is not a household item. The limitation will not apply to donations of paintings, antiques, other objects of art, jewelry and gems, and collections. A collection is something with value independent of its component parts. The proposal will take effect for years beginning after the date of enactment.

Other property

The JCT is also concerned that donors often overvalue donations of other property, in addition to the areas previously discussed. If the value of the donated property exceeds $5,000, the donor must obtain an appraisal to establish a value. The donor must attach the appraisal to Form 8283 and have that form signed by the charity to acknowledge receipt.

If the donation consists of tangible personal property that your organization does not use to carry out its exempt purpose, the donor's deduction is limited to the tax basis under current law. Tax basis is generally the donor's cost less any depreciation claimed against taxable income. For items of real or personal property, such as real estate and paintings, if you sell (or otherwise dispose of) them within two years of the donation, you must notify the donor and the IRS if the item was worth more than $5,000 when donated. You do this by filing Form 8282 with the IRS.

There are two alternative proposals presented by the JCT. The first would limit the deduction for any donation of property to the lesser of the donor's basis or fair market value. This proposal would not apply to donations of publicly traded securities, which would still have a fair market value deduction. This is viewed as a simplification proposal, as it would eliminate any need for appraisals and Form 8282. The proposal would not apply to any type of property subject to other rules as to deductibility (other limitations or enhanced deductions).

The second proposal would continue to allow a fair market value deduction for property used to substantially further your exempt purposes. There would be a recapture rule if you dispose of the property within three years of receipt, which would still require Form 8282, with the trigger amount reduced to $500 from $5,000. This option would require your organization to explain the intended exempt use of property that is so identified, with penalties for knowingly making misstatements. This may require the donor to report taxable income if the property does not sell for at least the amount of the donor's claimed deduction.

The proposals would take effect for years beginning after enactment. The JCT recognizes that many organizations obtain substantial non-cash donations of property. However, they are concerned that the loss to the U.S. Department of the Treasury from excess deductions exceeds any benefits to organizations. They hope that enactment of these proposals would encourage donations of cash or securities, or would cause donors to sell the assets, pay the capital gain taxes, and donate the balance in cash. It is difficult to know whether any of these positions are accurate.

Conservation and facade easements 

The JCT's concerns in the area of conservation and facade easements are similar to the other areas. Donors who place limitations on the use or facade of their property and donate these rights to charities are voluntarily limiting its future use. Therefore, current law allows a deduction for the decline in fair market value caused by the restrictions.

The concern is that this type of restriction is difficult to evaluate, requires appraisals, and often ends up with "dueling appraisers" if the IRS challenges the deduction claimed. Also, many residential properties in historic areas of cities are already subject to restrictions imposed by local legislation. The JCT and IRS believe the same or similar restrictions offered by the donors of these easements do not further reduce the property's value and should not provide tax deductions.

The proposals would eliminate any deduction for facade and conservation easements related to personal residence properties. They would substantially reduce the deduction for other qualified conservation contributions and would impose new standards on appraisals and appraisers of such donations.

If the donor owns a certified historic structure, as defined in current law, there will be no deduction for the contribution of a facade easement if the property is or recently was used as a personal residence of the donor or a family member. The deduction for donations of any other facade easements of certified historic properties will be limited to the lesser of 5 percent of the fair market value of the structure or 33 percent of the value of the facade easement. For example, if the structure is worth $1 million, and the facade easement is said to reduce the value to $700,000, the deduction is limited to $50,000, i.e., the lesser of $50,000 (5 percent of $1 million) or $99,000 (33 percent of $300,000).

Donations of real property for other conservation purposes will be reduced by 67 percent of the fair market value of the contributed interest. The idea is that this reduction lessens the impact of valuation abuses and the consequent loss of tax revenues. The proposal also tightens the eligibility rules by limiting eligible programs to those "pursuant to a clearly defined federal, state or local government conservation policy."

The proposal provides requirements for qualified appraisers for easement donations. Qualified appraisers will have to meet educational standards, as well as certify that they regularly perform appraisals and that they are not subject to disbarment before the IRS.

The JCT was charged to find revenue sources, and these proposals are all aimed at raising tax collections. At the time this is written, no formal legislative language is on the table, but enactment of provisions such as these are likely to be included. If you rely on in-kind donations for much of your income, you should be mobilizing your contacts to make your position known. If your services will be affected by these changes, Congress needs to know that to make an intelligent decision.

The JCT proposals are well reasoned and will resonate in the "anti-abuse" culture that we are in. Therefore, you should carefully watch the progress of the legislation and make sure your interests are protected.

Harvey Berger, CPA, is a partner and national director of not-for-profit tax services in Vienna, Va., for the accounting and management consulting firm Grant Thornton LLP. His email address is: [e-mail]. D. Greg Goller, CPA, is the partner-in-charge, Not-For-Profit Solutions Group in Grant Thornton LLP's Washington, D.C. office. His email is [e-mail]