Your clients may ask about donating used vehicles to charitable organizations. Donating a car is a good way to get a tax deduction, but increased scrutiny by the IRS means taxpayers need to have a good understanding of the rules related to the items claimed on their return.
Clients should be told about special limitations and substantiation requirements under Sec. 170(f)(12) as well as applicable general requirements for charitable contributions as itemized deductions. They should also be aware that charities usually sell the vehicle through a third party. In such cases, the deduction is based on proceeds of the sale, which may be less than what the donor considers fair market value (FMV).
The statute specifies that taxpayers must substantiate donations of motor vehicles (including automobiles, boats, airplanes, and motorcycles) with a claimed value of more than $500 by a contemporaneous written acknowledgment from the organization receiving the vehicle and that the taxpayer must attach the acknowledgment to the tax return that includes the deduction. The acknowledgment must contain specific information about the vehicle and certifications by the organization of its use and disposition. For the acknowledgment to be contemporaneous, the donee organization must provide it to the taxpayer within 30 days after the sale or contribution.
For such vehicles, the allowable deduction is the lesser of FMV at the time of the donation or, if the charity sells the vehicle without making any material improvement or using it to a significant extent, gross proceeds the organization receives from the sale. The gross sales proceeds limitation does not apply if the organization gives the vehicle to a needy individual in furtherance of its charitable purpose or sells it for significantly less than FMV to such an individual.
Notice 2005-44 defines “material improvement” as a major repair or improvement that improves the condition of the qualified vehicle in a manner that significantly increases its value. The cost of a material improvement may not be funded by an additional payment to the organization by the vehicle’s donor. Cleaning, minor repairs, routine maintenance, and removal of dents and scratches are not considered material improvements.
The charitable organization must complete and send to the IRS a Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes. Copy B of Form 1098-C can be sent to the donor as the contemporaneous written acknowledgment of the donation.
For vehicles with a claimed value of $500 or less, but more than $250, only the general substantiation requirements under Sec. 170(f)(8) apply: Principally, the organization must provide the donor a contemporaneous written acknowledgment describing the vehicle (but not necessarily its value) and stating whether the organization provided the donor any goods or services in consideration for it and, if so, a description of them and a good-faith estimate of their value.
For charitable contributions of property worth more than $5,000, the substantiation requirements under Sec. 170(f)(11)(C) generally require the donor to obtain a qualified appraisal and attach it to the return. However, vehicles are an exception, as long as the written acknowledgment by the organization states that the vehicle was sold without significant intervening use or material improvement and the donor deducts no more than the amount of the sale proceeds. If the vehicle has a claimed value of more than $5,000 and the organization does not sell the vehicle, the appraisal requirements apply.
An acceptable measure of the FMV of a donated car is an amount not in excess of the price listed in an established used-vehicle pricing guide (such as Kelley Blue Book or the National Automobile Dealers Association Used Car Guide) for a private-party sale (not the dealer retail value), in the same geographic area of a similar vehicle. However, the FMV may be less than the amount listed if the vehicle has engine trouble, body damage, high mileage, or excessive wear. Some charitable organizations advertise that taxpayers can donate vehicles in any condition and the donor can take a deduction equal to the full Blue Book value. However, the taxpayer needs to be prepared to substantiate the deduction on a tax return, knowing that the IRS’s system will perform automated matching of contributions reported by charitable organizations to the deductions claimed. Discrepancies can trigger an audit. Overvaluation of donated vehicles relative to their condition is an area of abuse that is of concern to the IRS.
In addition, Sec. 6720 prescribes potentially severe penalties for fraudulent acknowledgments of vehicle donations or for failing to provide a Form 1098-C or other proper acknowledgment to the donor and to the IRS where required. The IRS emphasized this point in Notice 2006-1.
By Kamala Raghavan, CPA, CGMA, DBA, CFP, (firstname.lastname@example.org) an associate professor at Texas Southern University in Houston.
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