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Wednesday, May 1, 2024
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Case Studies |
Getting Back to the "Art of the Matter," Part 3
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Case:
Paulo Frambini, 45, is a talented artist and a self-proclaimed leader of the art purist movement. He lives, breathes and eats art history and culture. Paulo refuses to be characterized as any one particular type of artist. Accordingly, Paulo's artistic creations are very diverse and varied. In fact, during the past year, he painted a traditional 17th century landscape piece and he sculpted a giant dolphin out of a 2000-pound marble block. In addition, he also purchased a modern abstract piece made entirely out of used car parts.
Not surprisingly, Paulo strongly supports the arts in his community. He frequently gives workshops and tours at the local art museum. In addition, Paulo also is fond of the local art college where young new talent is groomed and developed everyday.
Paulo desires to make a substantial contribution to charity this year. Specifically, he would like to give his three new pieces to charity. However, he wants to take full advantage of the tax benefits associated with charitable giving.
Question:
What are the tax consequences if Paulo gives the modern abstract piece to the art museum? Does it matter whether the art museum displays the piece? Why or why not?
Solution:
Gift of Modern Abstract Piece to Art Museum: When dealing with gifts of artwork, the first step is to determine the type of asset being contributed as defined by the tax code. If a donor is the creator of the work of art, then it is an ordinary income asset to the donor. Alternatively, if a collector holds the work of art for investment purposes, then it is a capital asset.
Second, since art is tangible personal property, the charitable deduction for a gift of art will depend also upon whether the property is put to a "related" or "unrelated use." A related use gift occurs when the charity actually makes use of the property in a manner consistent with its exempt purpose.
In this case, Paulo purchased the modern abstract piece as an investment. Therefore, the piece is deemed a capital asset. Assuming he purchased the property at least a year and one day ago, the piece would further be classified as a long-term capital asset. Because of this determination, the ordinary income reduction rules are inapplicable.
Paulo purchased the piece for $10,000 and, due to its creator's death, it has since appreciated in value to $50,000. Normally, gifts of long-term capital assets produce a charitable deduction equal to the fair market value of the property. However, artwork is subject to the tangible personal property/unrelated use rules.
If the property qualifies as related use property, then the gift of an appreciated artwork produces a charitable deduction equal to its fair market value. However, a gift of tangible personal property for an unrelated use produces a deduction only for cost basis, so long as the cost basis does not exceed fair market value.
In this case, the art museum informed Paulo that they intend to display the modern piece in their modern art exhibit. Therefore, the charity is using the property in a manner consistent with its exempt purpose. Accordingly, as a related use asset, Paulo's charitable deduction will equal the fair market value of the piece or $50,000. This deduction is useable up to 30% of adjusted gross income in the current year. This rule is similar to the deduction limit for a gift of appreciated stock or land. Any unused deduction may be carried forward five additional years.
Editor's Note: For a related use charity will give a letter to the donor. The letter should identify the property, state the date of the gift and describe briefly the use and the reasons why that use is related to the exempt purpose of the charity. At one time, it was permissible to take a related use deduction for a gift to a charity if the donor had a "reasonable anticipation" that the gift will be used for an exempt purpose. However, actual use is now required. Reg. 1.170A-4(b)(3)(ii)(b).
There is a recapture of tax benefits if a charitable organization disposes of related-use tangible personal property within three years of the gift. Recapture applies to related-use appreciated tangible personal property for which a deduction of more than $5,000 is claimed. In effect, there is a three year holding period for tangible personal property valued over $5,000 that is claimed to be used for a related use. If the property is sold in the first year, the charitable deduction is reduced to basis. Sec. 170(e)(1)(B)(i). If the property is sold after the first year and within three years of the gift date, the donor will include in taxable income the difference between the basis and the claimed deduction. Sec. 170(e)(7)(A).
There is an exception that allows the charity to make a statement under penalty of perjury that the related use has become impossible and, therefore, the tangible personal property had to be sold. The statement must either describe how the property was used in a manner related to exempt purpose or state the intended related use at the time of the contribution and certify that such use became impossible or infeasible to implement. The organization must furnish a copy of the certification to the donor (for example, as part of Form 8282, a copy of which is supplied to the donor). Sec. 170(e)(7)(D).
The Form 8282 requirement of reporting the sales of Form 8283 property applies to sales within three years of the gift date. The donee organization must also provide a description of the donee's use of the property, a statement of whether use of the property was related to the purpose or function constituting the basis for the donee's exemption and, if applicable, a certification of any such use (described above). A penalty of $10,000 applies to a person who identifies tangible personal property as having a use that is related to a purpose or function constituting the basis for the donee's exemption knowing that it is not intended for such a use. Sec. 6720B.
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