Two Key Pitfalls To Avoid When Gifting Closely-Held Business Interests - Part TwoSubmitted by American Endowment Foundation on September 16th, 2019
By Laura Malone
Part Two of a Two-Part Series
Qualified appraisals by a qualified appraiser…. what does this mean?
It is often thought by donors, and some advisors, that if the donor contributes $1M of business stock to a charity, that their charitable deduction is $1M as well. While it is easy to understand why that would be the assumption, the IRS does not work that way.
The IRS requires that any property donated that is valued to be more than $5,000, be substantiated by a qualified appraisal made by a qualified appraiser. In fact, if the donor is trying to claim a deduction of more than $500,000 for a donation of property, they must attach a qualified appraisal of the property to their return.
The donor must pay out of pocket and may not take a charitable contribution deduction for fees paid for appraisals. However, these fees may qualify as a miscellaneous deduction, subject to the 2% limit, on Schedule A (Form 1040) if paid to determine the amount allowable as a charitable contribution.
Per IRS guidelines, a qualified appraisal is an appraisal document that:
- Is made, signed, and dated by a qualified appraiser in accordance with generally accepted appraisal standards,
- Meets the relevant requirements of Regulations section 1.170A-13(c)(3) and Notice 2006-96, 2006-46 I.R.B. 902 (available at www.irs.gov/irb/2006-46_IRB/ar13.html),
- Relates to an appraisal made not earlier than 60 days before the date of contribution of the appraised property,
- Does not involve a prohibited appraisal fee, and
- Includes certain information1.
The IRS lists 11 items of information that need to be included in a qualified appraisal. Some of these are unique to the scope of this being a charitable gift and therefore a general appraisal done for regular business purposes cannot be used. These unique attributes are:
The date (or expected date) of contribution,
The appraised Fair Market Value (FMV) on the date (or expected date) of contribution,
- A statement that the appraisal was done for income tax purposes,
- The terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor that relates to the use, sale, or other disposition of the donated property, including, for example, the terms of any agreement or understanding that:
- Temporarily or permanently restricts a donee's right to use or dispose of the donated property,
- Earmarks donated property for a particular use, or
- Reserves to, or confers upon, anyone (other than a donee organization or an organization participating with a donee organization in cooperative fundraising) any right to the income from the donated property or to the possession of the property, including the right to vote donated securities, to acquire the property by purchase or otherwise, or to designate the person having the income, possession, or right to acquire the property.
While a general appraisal cannot be used, if a company does regular appraisals, it may be possible that that information could expedite the process in creating the charitable appraisal. This can also reduce the cost of the appraisal to the donor because there is no need to begin the process “from scratch”. If the donor already has a relationship with a qualified appraiser, it is helpful to seek feedback from that person as to what may be the easiest and most efficient course of action to take.
A qualified appraiser is someone who has what the IRS considers to be the relevant background including experience, education, membership in professional appraisal associations, and is not an excluded individual (donor, donee, another participant to the transaction or any employee/relative of those parties). It cannot be a party to the transaction or their representatives. Nor can it be a relative/employee of any of the parties to the transaction.
The information in the qualified appraisal is critical in the completion of IRS Form 8283 which is required for the donor to receive their charitable deduction. If the gift is over $500,000, the appraisal has to be attached along with the Form 8283. It is extremely important to note that the donor will not get a deduction without providing the IRS the 8283 tax form (signed by the charity), a qualified appraisal as applicable, and the tax receipt letter from the charity or donor advised fund that substantiates receipt of the gift.
While these pitfalls seem like a lot to consider, they are often overshadowed by the benefits received by the donor in making these types of gifts. Often closely-held business interests are some of the most highly appreciated assets that a donor has, so the ability to get the charitable deduction and avoid paying capital gains tax on the amount of ownership donated can create a significant tax benefit allowing them to preserve more wealth. Beyond the tax benefits, a donor can also build something of significance beyond their business.
Keep in mind that some charitable organizations may simply be unwilling to accept such an asset due to their lack of understanding of how to convert it into usable cash. Some donor advised fund administrators may also be unwilling to engage in such illiquid gifts due to a lack of understanding of how to manage the complexity involved. Finally, it is extremely important to make sure these strategies are not implemented without tax and legal guidance from the owner’s professional team.
At American Endowment Foundation, we look forward to taking the complexity out of complex assets. Please contact us or call at 1-888-966-8170 to discuss your specific circumstances.
Read Part One of this Two-Part Series