Not-for-profit organizations often struggle with valuing non-cash and in-kind donations, including the value of houses and other real estate. Whether for recordkeeping purposes or when helping donors understand proper valuation for their charitable tax deductions, the task isn't easy.
Although the amount that a donor can deduct generally is based on the donation's fair market value (FMV), there's no single formula for calculating FMV for every type of gift.
Note: A donor can't claim a tax deduction for the contribution of services. Thus, this article focuses on valuing gifts of property for tax purposes rather than financial accounting purposes.
The IRS defines FMV as the price that property would sell for on the open market. For example, if a donor contributes used clothes, the FMV would be the price that typical buyers actually pay for clothes of the same age, condition, style and use.
If the property is subject to any type of restriction about its use, the FMV must reflect that restriction. Say a donor contributes land to your nonprofit and restricts its use to agricultural purposes. The land must be valued for agricultural purposes, even though it would have a higher FMV for residential purposes if it were used to build homes. Ultimately, FMV must consider all facts and circumstances connected with the property, such as its desirability, use and scarcity.
According to the IRS, there are three particularly relevant factors in determining FMV:
1. Cost or selling price. The cost of the item to the donor or the actual selling price received by your organization may be the best indication of the item's FMV. Because market conditions can change, though, the cost or price becomes less important the further in time the purchase or sale is from the date of contribution.
For example, you may have paid $2,000 for a top-of-the-line laptop in 2018. But that computer certainly isn't worth $2,000 anymore because it's no longer top of the line. It may still have some value, though.
A documented arm's-length offer to buy the property close to the contribution date may help prove its value to the IRS. The offer must have been made by an independent, unrelated party willing and able to complete the transaction.
2. Comparable sales. The sales price of a property similar to the donated property often is critical in determining FMV. The weight that the IRS gives to a comparable sale depends on the:
The degree of similarity must be close enough that reasonably well-informed buyers or sellers of the donated property would have considered that selling price. The greater the number of similar sales for comparable selling prices, the stronger the evidence of the FMV. It's important, though, that transactions take place in an open market. If sales were made in a market that was artificially supported or stimulated, they might not be representative or indicative of the FMV. For example, liquidation sale prices typically don't indicate FMV.
3. Replacement cost. FMV should consider the cost of buying, building or manufacturing property similar to the donated item after a reduction for the age and depreciation of the property being donated. But the replacement cost must have a reasonable relationship to the FMV. And if the supply of the donated property is more or less than the demand for it, replacement cost becomes less important to FMV.
If a business donates inventory, it can deduct the smaller of its FMV on the day of the contribution or the inventory's basis. (The basis of donated inventory is any cost incurred in an earlier year to purchase or create the inventory that the business would include in its opening inventory for the year of the contribution.) If the cost of donated inventory isn't included in the opening inventory, its basis is zero and the business can't claim a charitable deduction. Instead, the cost of the donated inventory will be included in current year cost of goods sold, showing zero as the corresponding sale.
Special rules apply to donations of food inventory. The food donated must be wholesome and intended for human consumption even if it may not be marketable at the time of the donation. A business may get a tax deduction that includes up to one-half of the profit margin it would have received if the food had been sold on the date of the donation. For assistance with the detailed calculations, check with your tax advisor.
Even if a donor can't take a tax deduction for a non-cash or in-kind donation (usually a piece of tangible property or property rights), you may need to record the donation on your financial statements. Recognize such donations, including the donation of services, at their fair value, or what it would cost if your nonprofit were to buy the donation outright from an unrelated third party.
Potential donors might be deterred because of the hassle involved in getting non-cash donations appraised. Yet appraisals generally aren't needed for items of property for which the donor will claim a deduction of $5,000 or less.
Donors who deduct more than $500 for any single item of clothing or any household item that isn't in "good used condition" or better, however, must include a qualified appraisal with their income tax returns. In these cases, the donor should understand that the IRS will weigh the appraisal based on the report's completeness and the appraiser's qualifications and demonstrated knowledge of the donated property.
The IRS and courts are requiring donors to follow the requirements for appraisals — even when the value of the property is certain.
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