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Wednesday, May 1, 2024
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Case Studies |
Gift of Art to Museum Paints Donor into a Corner
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Case:
Michael Prawn, 45, is an avid art collector. He specializes in fine paintings and frequently travels around the world looking for new pieces. Michael is famous for finding 'great deals' in small towns no one had ever heard of. For instance, in 1992, while Michael was vacationing in Romania, he got completely lost during a countryside excursion. He ended up in this small village, Losov, that had no electricity or telephones. While looking for someone to guide him back to civilization, he came across an out-of-the-way shop with an original painting, circa 1820, by Paul Rothschild, hanging on a wall. Amazed, Michael quickly bought the piece for $10,000. Today, a Rothschild typically sells at auction for $200,000. Obviously, Michael lived up to his reputation as a 'great deals' collector with that find.
Currently, Michael is on the Board of the local museum, which has just begun a fundraising effort. The gift planning officer for the museum has approached Michael about making a lead current or deferred gift. Michael is aware of charitable remainder trusts (CRTs) and the benefits associated with them. Therefore, he decides to create a Retirement CRT (a net income with makeup CRT) funded with his Rothschild painting. The art museum would be the irrevocable remainder beneficiary of the CRT. During discussions about the Rothschild, the gift planner recalls that gifts of tangible personal property are subject to some severe reduction rules. However, he remembers that if the personal property is related to the charity's tax-exempt purpose, the reduction rules may be avoided.
Question:
What is the proper tax treatment of Michael's gift of a Rothschild painting to a CRT that will benefit an art museum? Should Michael fund his CRT with the painting or should he consider another option?
Solution:
As a general rule, gifts of tangible personal property produce a charitable contribution deduction equal to the donor's cost basis in the property. See Sec. 170(e)(1)(B). In our case that would mean Michael's deduction would be based upon his $10,000 cost basis. However, when the tangible personal property is used for a purpose related to the charity's exempt purpose, no reduction is necessary. Here, the art museum's purpose is to display art. If it received a painting from a donor and planned to use the artwork in the museum, that would constitute a related use. Therefore, the donor's charitable contribution deduction would be based on its fair market value instead of its cost basis.
In this instance, it would appear that Michael's contribution of his Rothschild painting to the art museum would produce a fair market value deduction under the related use exception. However, gifts of tangible personal property to a unitrust are generally deemed an unrelated use. See Reg. 1.170A-4(b)(3). The rationale underlying the regulation is that the trust does not intend to use the property but instead intends to sell the property. The fact that the proceeds of the sale would be used to benefit the charity does not alter the result. Hence, Michael's transfer of his painting to a CRT would be deemed an unrelated use, and consequently, his deduction would be based upon his cost basis in the painting of $10,000.
After considering the importance of a large charitable deduction and his overall retirement plan, Michael opts to transfer the Rothschild outright to the art museum. He realizes that his finances are such that it is very unlikely he would need the CRT income in future years. Also, his lead current gift of $200,000 would set a wonderful standard for other Board members and friends of the museum. Because the museum intends to display the Rothschild in its exhibits ("related use"), Michael will be entitled to a fair market value charitable contribution deduction of $200,000.
Editor's Note: In the event that Michael had decided to proceed with his tangible personal property gift to the CRT, one special rule should be noted. No current tax deduction is allowed until the donor is divested of all rights to possession or enjoyment of the property. See Sec. 170(a)(3). Therefore, under the "intervening interest rule," Michael would not be entitled to a charitable contribution deduction until the trustee sold the painting. Accordingly, the gift would be deemed made at that time under Sec. 170.
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