In-Kind Donations to Charities—the Problem of Overvaluation and Other Issues
With respect to gifts of both tangible and intangible property, we have seen overvaluation by some taxpayers to inflate the charitable contribution deduction at public expense. Valuation issues can be especially difficult. The Administration’s FY 2005 Budget includes several proposals to address the problem of overvaluation of donated property. But there can be other problems as well.
A key issue in intellectual property donations, as in all other property donations, is whether the property has been appropriately valued. In the case of patent and other intellectual property donations in particular, we have concerns about overvaluation, whether consideration has been received in return, and whether only a partial interest of property is being transferred. To address valuation concerns, the Administration’s FY2005 Budget includes a proposal to limit the taxpayer’s initial deduction for contributions of certain intellectual property to the lesser of the taxpayer’s basis in the property or the fair market value of the property. Under the proposal, the taxpayer would be permitted to deduct certain additional amounts based on the amount of revenue, if any, actually received by the charity from the donated property. The Administration’s Budget also includes a proposal to require all taxpayers (including C corporations) to obtain a qualified appraisal of property (other than inventory property and publicly traded securities) if the deduction claimed exceeds $5000, and to attach a copy of the appraisal to the taxpayer’s return if the deduction claimed exceeds $500,000.
In addition to these legislative proposals, we have issued Notice 2004-7, 2004-3 I.R.B. 310, which is aimed at donors, promoters, and appraisers. The Notice reminds taxpayers that transfers of property are not deductible:
- If the transfer is of a partial interest in property.
- To the extent that consideration is received for the transfer.
- If the transfer is inadequately substantiated.
- To the extent the property is overvalued.
The Notice reminds taxpayers that the fair market value of a patent must take into account whether the patented technology has been made obsolete by other technology; any restrictions on the donee’s use of, or ability to transfer the patented technology; and the length of time remaining before the patent’s expiration.
Conservation easements placed on land or buildings have become a significant part of environmental and historic preservation movements. Some charities exist primarily to receive and hold land and easements in perpetuity to prevent development.
Although easements represent a valued part of philanthropy, let me briefly summarize some of the issues we have seen. As stated, gifts of partial interests in property are ordinarily not deductible. An easement, of course, is only a partial interest. However, section 170(f)(3) provides an exception to the partial interest rule for qualified conservation contributions such as conservation easements.
We have seen several abuses in this area. There have been cases where the easement being donated is overvalued. There are also cases in which the donor, or the donor’s successor in interest, takes an action inconsistent with the easement without adverse consequences. The conservation easement rules place the charity in a watchdog role over the easements it possesses. If the charity fails to monitor these properties (another failure in governance), the potential exists for inconsistent use by the landowner of the property upon which the original deduction was premised. In other cases, taxpayers are claiming large deductions when they are not entitled to any deduction at all (e.g., when taxpayers fail to comply with the law and regulations governing deductions for contributions of conservation easements).
We have developed guidance to remind donors and charities the legal requirements for a conservation easement contribution. We expect that this guidance, examination in this area, and the forms changes and one of the compliance initiatives described below, will improve compliance in the area of easements donations.