Charitable Deduction for Ordinary Income Property

When donating property to a qualified charitable organization, the rules for calculating your tax deduction depend on the type of property. The amount you can deduct is not always the property’s fair market value at the time of the gift. This article focuses on the specific regulations for a category of assets known as ordinary income property.

Defining Ordinary Income Property

Ordinary income property is a specific classification of assets for tax purposes. The core principle is that it’s any property which, if sold at its fair market value on the date it was contributed, would have generated ordinary income or a short-term capital gain for the donor. This treatment contrasts with property that would produce a long-term capital gain if sold.

A common example of ordinary income property is inventory, which consists of items a business holds for sale to its customers. Similarly, accounts receivable generated by a business that provides services are considered ordinary income property.

Another category includes creative works when donated by the person who created them. This applies to assets like artwork, manuscripts, and musical compositions. The tax code treats the sale of such items by their creator as ordinary income.

Finally, the holding period of a capital asset is a determining factor. Any capital asset, such as stocks or bonds, held for one year or less is classified as a short-term capital asset. Donating a capital asset you have owned for a year or less means you are contributing ordinary income property.

Calculating the Charitable Deduction

The calculation for a charitable deduction involving ordinary income property is limited to the lesser of the property’s fair market value (FMV) at the time of the contribution or its adjusted basis. This rule prevents a taxpayer from receiving a tax benefit for appreciation that would have been taxed as ordinary income if the property had been sold.

Fair market value is defined as the price at which property would change hands between a willing buyer and a willing seller. Adjusted basis is the asset’s original cost, plus any improvements, minus any depreciation taken. For inventory, the basis is the cost to produce or purchase the item.

Consider a hardware store that donates a lawnmower from its inventory to a local community center, which is a qualified charity. The lawnmower has a retail price, or FMV, of $400. The store’s cost to acquire the lawnmower, its adjusted basis, was $250.

Under the rules for ordinary income property, the store’s deduction is not the $400 FMV. The deduction is limited to the lesser of the $400 FMV or the $250 adjusted basis. Therefore, the hardware store can only claim a $250 charitable deduction.

Special Rule for Qualified Inventory Contributions

An exception exists that provides an enhanced deduction for certain business contributions of inventory. This rule applies to “qualified contributions.” To be eligible, the donated inventory must be for the care of the ill, the needy, or infants, and the inventory must conform to the Federal Food, Drug, and Cosmetic Act.

This enhanced deduction is primarily available to C corporations. The deduction is calculated as the property’s basis plus one-half of the appreciation in value. The appreciation is the difference between the FMV and the basis.

There is a limitation to this enhanced calculation: The total deduction cannot exceed twice the basis of the donated property. For example, imagine a C corporation donates medicine with an FMV of $1,000 and a basis of $300. The appreciation is $700.

Half of the appreciation is $350. The potential deduction is the basis ($300) plus half the appreciation ($350), which equals $650. The final check is against the limitation of twice the basis, which is $600 (2 x $300).

Since $650 is greater than $600, the deduction is capped at $600. This provision offers a greater tax incentive for corporations to donate needed goods.

Reporting Requirements for Noncash Donations

After determining the correct deduction amount, specific reporting procedures must be followed. The deduction is claimed as an itemized deduction on Schedule A of Form 1040. For any noncash contribution, taxpayers should obtain and keep a receipt from the charitable organization.

If the total deduction claimed for all noncash gifts in a year exceeds $500, the taxpayer must file Form 8283, Noncash Charitable Contributions, with their tax return. This form requires details about the donated property and the recipient organization.

The requirements become more stringent for higher-value donations. If the deduction for a single item or a group of similar items is over $5,000, Section B of Form 8283 must be completed. This section requires the taxpayer to obtain a written qualified appraisal, and the charity must also acknowledge receipt by signing the form.