Thursday March 28, 2024

1.5.1 Fair Market Value

Percent Deduction Limits

Fair Market Value:  Property is bought and sold every day between willing buyers and willing sellers.

Publicly Traded Stocks and Bonds:  Stocks and bonds that are traded on a public exchange are relatively easy to value.

Real Estate:  Applying the willing buyer and willing seller test to real estate is slightly more complicated.

Mutual Fund Shares:  Mutual fund shares are valued as of the close of the market each business day.

Life Insurance:  Life insurance may also be valued under the willing buyer - willing seller test.

Art:  Art is in the eye of the beholder.

Valuation Penalties:  There are two general categories of valuation penalties.

Fair Market Value

Property is bought and sold every day between willing buyers and willing sellers. The determination of value for any charitable gift is simple. It is merely the value that a willing buyer would pay a willing seller. However, the specific rules for determining value can vary considerably. Cash is, of course, worth its face value and public securities can be valued by their worth on an exchange, but other assets are more difficult to value. Thus, there are specific rules for valuing stocks, real estate, mutual funds, life insurance, art and other types of property. Reg. 20.2031-1(b).

Publicly Traded Stocks and Bonds

Stocks and bonds traded on a public exchange are relatively easy to value. The value for stock given on a particular day is the mean between the high and low sales on that day. If there have been no sales, the value is determined by a weighted average of the mean sale price on the gift date. Reg. 20.2031-2(b)(1). If there are no actual sales of a security during a reasonable period, then the same weighted average method may be used. However, in this case, the bid and asked prices are used for the weighting formula. Reg. 20.2031-2(c).

Example 1.5.1.A Weighted Average

A stock is sold on January 3rd and the high and low are 52 and 48. Thus, the mean for January 3rd is 50. There are no more sales until January 13th. On that date, the stock sells between 60 and 50, producing a mean of 55. A donor makes a gift of 100 shares of stock on January 7th. Since January 7th is day four of the 10-day period, the price is 40% of the difference between 50 and 55. The difference is $5 and 40% of $5 is $2. The weighted value is $50 plus $2, or $52 per share. The charitable deduction for 100 shares is $5,200.

Real Estate

Applying the willing buyer and willing seller test to real estate is slightly more complicated. First, real estate may be either improved or unimproved. If real estate is improved, then a qualified appraiser must evaluate both the land and the buildings or other structures.

Second, real estate valuation must consider several other factors. Rev. Proc. 79-24. Normally, the most reliable valuation is comparable sales of similar property. Rev. Proc. 66-49. However, there may be other factors that affect the value of the property, such as use restrictions, limitations due to restricted access or zoning requirements. Rev. Proc. 96-15.

Mutual Fund Shares

Mutual fund shares are valued as of the close of the market each business day. The transfer of a mutual fund results in a charitable deduction equal to the number of shares times the value as of the end of the day on the date of transfer. If the gift is given on a non-trading day (when there is no valuation), then the last prior closing valuation will be used. Reg. 20.2031-8(b)(1).

Life Insurance

Life insurance may also be valued under the willing buyer - willing seller test. If there is an increase in value over the premiums, then the charitable gift deduction will be reduced by the ordinary income element. Sec. 170(e)(1). For a paid-up policy, the deduction is the lesser of premiums paid or the replacement cost of the policy for a person the age of the insured. Reg. 20.2031-8(a)(3).

For most policies with remaining premiums to be paid, the "interpolated terminal reserve value," or ITRV, is used in determining the value. The ITRV is generally the cash value plus a pro-rated portion of the last premium paid. Reg. 20.2031-8(a)(3). The charitable deduction is the lesser of IRTV or premiums paid.

With the growth of viatical settlements, some persons in poor health are able to sell policies for an amount considerably in excess of the ITRV. The excess over the ITRV is usually long-term capital gain in this circumstance. Thus, the gift of a policy in such a circumstance may produce a deduction both for the basis of the policy and for the long-term capital gain element. Sec. 170(e)(1)(A). However, the ordinary income element would reduce the deduction.

Art

Art is in the eye of the beholder. As one federal judge reviewing an art valuation case once noted, "We observe that the objects in this case are referred to as art merely for the sake of convenience."

Works of art are subject to the same willing buyer - willing seller test as other assets. Understandably, there is great diversity in both the type of art and the determination of value. In order to review art valuations, the Treasury has created the IRS Art Advisory Panel. The panel reviews art items and recommends valuation adjustments. Inevitably, the panel frequently recommends valuation reductions for items given to charities and increases in value of items transferred to family members.

To allow taxpayers to obtain a Statement of Value from the Service, there is a provision that allows the Treasury to determine the value of gifts already made to a charity. Rev. Proc. 96-15. If the appraised value is over $50,000, the donor may request a Statement of Value by paying a fee of $2,500 and requesting the statement by January 15th. If these requirements are met, the IRS will issue a determination of value by June 30th.

Valuation Penalties

There are two general categories of valuation penalties. If the claimed value is 200% or more of the actual value, an underpayment of income tax over $5,000 may be subject to a penalty of 20%. Sec. 6662(e)(1)(a). Furthermore, if the claimed value is in excess of 400% of the correct value, there may be a 40% penalty on the underpayment of tax. Sec. 6662(h)(1).

Clearly, Treasury is interested in preventing valuation abuses. The donors may avoid the valuation penalties by obtaining a qualified appraisal and making a good faith review of the appraisal and the surrounding circumstances. Sec. 6664(c)(2). Therefore, for donations of valuable works of art, it is important for the donor both to obtain a qualified appraisal and to be able to document a reasonable level of review of comparable works of art.


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