I’ve heard that we are permitted to deduct gifts of retirement assets to charity, but that the process is more complicated than a gift of cash or even of securities. As my retirement account is the bulk of my estate and I doubt I’ll use all of what I have, I think some, if not all, of it would be a perfect charitable gift. What do I need to look out for?
This issue, a perennially hot one among donors and fundraisers alike, has been dogging Congress for decades. Part of the problem is that Congress just can’t make up its mind. As it stands now (as of the end of 2014), you are not permitted to make a charitable gift of an IRA asset without tax consequence. But wait. This may change, as Congress is considering making the provision, even though it expired without continuation at the end of 2014, permanent.
Let me explain what I mean by “without tax consequence,” in the event that the provision is reinstated as it was. IRA donations would not be tax deductible. Instead, the transfer to charity would simply not be a tax event, which means that – and this is key – taking the money out of your account to be assigned to a charity will not trigger a tax. Typically, when the money is not going to charity, you pay an income tax when you take money out of an IRA. In what the IRS calls a qualified charitable distribution, you would be able to exclude up to $100,000 (at least that's been the limit in the past) from your gross income when the money is going to a charity - essentially a non-event from the IRS’s perspective.
How is that different from taking the money out, paying the tax, making a gift of the money and taking a deduction? For most people, there would be no difference. The benefit was evident only for the taxpayer who would otherwise hit the 50 percent charitable deduction-ceiling limit. That is, sometimes, because of his or her income level, a donor cannot use the entire deduction in the year the gift is made. As an IRA gift to charity would not be a taxable event, the ceiling limit would not apply, permitting donors to make their other gifts to charity without worrying whether the IRS gift will figure into the deduction limit.
But don’t forget about the benefits of a gift of retirement assets upon death, which have not been subject to Congress’s yo-yo mindset. Because of the special character of retirement assets, they are taxed twice at death. First they are included in a decedent’s final income tax return for tax consideration, and they are also included as part of the decedent’s estate. This is one reason not to leave retirement assets to children or other family members: the amount they receive after taxes is so little. At the same time it serves as an excellent reason to bequeath these assets to charity. Properly executed— the document must show the charity as a full or partial beneficiary and your will should be drawn up to reference that fact—the income and estate taxes are avoided and the charity receives a substantial gift.
I have a painting by Andrew Wyeth that I’d like to donate to my university. The people there say they might keep it, but they can’t guarantee it. They may sell it right away. If they sell it, my accountant says that I’ll be able to deduct only what I paid for it. But I didn’t pay anything for it. My father purchased it for $3,000 in 1954 and then he left it to me when he died in 1989. A recent insurance appraisal shows it to be worth around $600,000. Somebody else told me that if the university keeps the painting for at least three years, then—even if it later sells the painting— I’ll be able to get around the rule that limits my deduction to the cost basis. Is this true?
The most important question here is whether the university will use the painting. If it keeps the work and tells you that the painting will be displayed, then you will be able to deduct the entire value of the gift, within limits imposed by your adjusted gross income. That is, the gift would have a “related use.” If students and visitors can view the painting and therefore have a forum to appreciate it, the IRS is comfortable that the related-use rule is satisfied.
If the university immediately sells the painting, however, the gift fails the related-use test, and your deduction would be limited to the value of the asset on the date of your father’s death. Even though he paid $3000, undoubtedly it was worth more when he died. The general rule is that if the gift fails the related-use test, the donor is permitted to deduct the lesser of the cost basis or the market value. In your case, the cost basis is the stepped-up basis at your father’s death. You didn’t mention what that value was, so you’ll have to check his estate-tax return (if one was filed) to determine your cost basis for the gift.
But this “getting around the rule” business is a problem for me. You should never listen to anyone who advises you to scam the IRS. The problem is that the difference between a legitimate deduction and a shady deduction is not often clear. So here’s my advice: Some people think that if a charity holds the gift and sells it after three years, then the donor is safe in deducting the fair market value of an asset that has appreciated over time. This is not true. The related-use rule is just that: a rule that allows donors to take market-value deductions for tangible property gifts that further the mission of the charity. That is the only consideration; the timing of the sale is immaterial.
There is a reason for the confusion. When charities sell a donated asset (other than most publicly traded stock) within three years of receiving it, they must tell the IRS how much they sold it for. If the asset is held for more than three years, the charity does not have to report to the IRS what it receives when it is sold. But this is different from related use.
One more thing: The insurance appraisal won’t be good enough for the IRS. You’ll need to hire an independent appraiser who is qualified to appraise paintings. The appraisal needs to be conducted no later than 60 days before the gift is made and before you file your income tax return for the year. Also, don’t expect the charity to pay for the appraisal. It’s your obligation.