Charitable Gifts of Partial and Undivided Interests

For income tax purposes, a charitable deduction is generally not allowed for a gift of a partial (i.e., less than entire) interest in property, according to Sec. 170(f)(3)(A). However, Sec. 170(f)(3)(B) permits a deduction for a gift of an undivided portion of a donors entire interest in property.

Partial vs. Undivided Interests

How does a taxpayer distinguish between the two ways of gifting? When a donor retains a substantial right or interest in donated property, he or she has given only a partial interest, ineligible for a charitable deduction (unless such interest is in the form of a charitable remainder trust, pooled income fund, charitable lead trust, remainder interest in a personal residence, qualified conservation contribution or charitable gift annuity). Loans to charity are also partial interests for which no charitable deduction is allowed.

Definition: An undivided portion of a donors entire interest in property is a fraction or percentage of each and every substantial interest or right the donor has in the property. It must extend over the entire term of the donors interest and to other property to which such property is converted; see Regs. Sec. 1.170A-7(b)(1)(i).

While Sec. 170(a)(3) bars an income tax deduction for a gift of a future (e.g., remainder) interest in tangible personal property if the donor retains an intervening interest, Sec. 170(f)(3)(B)(ii) permits the deduction for a gift of an undivided interest in tangible personal property.

Example: X gives a ¹/12 undivided interest in a sculpture to a museum, allowing it to display it one month per year. He can take a charitable deduction for ¹/12 of the arts value. However, if X were to donate a remainder interest in the sculpture and retain a life estate, no income tax charitable deduction would be allowable.

A gift of an undivided interest is a good strategy to use when a taxpayer has a very valuable collectible and is unable to fully use the Sec. 170(b)(1)(B) charitable deduction, which is limited to 30% of  adjusted gross income. 

Letter Ruling 200223013

Facts: The donors (husband and wife) owned an art collection, some pieces of which they had already donated to a museum. Under a gift-and-loan agreement with that museum, the donors could make lifetime gifts of their entire undivided interest (but at least ¹/12) in any of their remaining art. If the donors transfer undivided interests, they will retain personal possession proportionate to their interest each year. As long as the museum complies with the agreement, the donors cannot make lifetime or testamentary transfers of their art to a third party; transfers can only be made to each other or to the museum. On the surviving spouses death, the museum will receive all of the donors remaining interest in the art collection, whether the works were gifted or loaned.

The agreement requires the museum to permanently display the collection, identify the works according to the donors specifications and pay all maintenance and conservation costs. If the museum breaches any of the gift conditions, its ownership rights in the entire collection will be transferred to another charity. If the breach involves any loaned works, they must be returned to the donors. All of the donors art is long-term capital gain property.

Holding: The IRS ruled that charitable deductions will be allowed for any lifetime gifts of undivided interest in the art. Although the donors retained some unsubstantial rights, they did not retain any reversionary interest in the works. Most importantly, the ownership rights in the art collection will be transferred to another charity if the museum violates the agreement.

Valuation: Rev. Proc. 96-15

When a client wants advance certainty on the IRSs position on the valuation of art or collectibles, he or she can use Rev. Proc. 96-15. The following requirements must be met to obtain a ruling:

1. The ruling request must be made after the property is transferred.

2. The taxpayer must have already obtained a qualified appraisal.

3. At least one of the items transferred must have a value of at least $50,000 or more.

4. Form 8283, Noncash Charitable Contributions, and a copy of the appraisal must be attached to the ruling request.

The fee for an advance determination is $2,500 for the first three items ($250 for each additional item). Once the ruling is given, it is binding on the IRS. The taxpayer, however, may still dispute it, by attaching (1) the ruling to the return on which the transfer is reported and (2) further information.

Strategy

This procedure may be useful in estate administrations when the executor needs to determine cash requirements. Clients who want certainty as to the tax results of a transfer of art by giftbut hesitate to make a transfer (and possibly pay gift tax) before an IRS rulingshould consider transferring the asset to an inter vivos qualified terminable interest property trust (QTIP) and obtain a valuation ruling under Rev. Proc. 96-15. As long as a QTIP election is made, the transfer will not result in any Federal tax. Once the value of the art is certified by the Services Art Advisory Panel, the transferor spouse could renounce his or her income interest in the QTIP trust, resulting in a taxable gift to the remainder beneficiaries under Sec. 2519. This offers a client the comfort of knowing that the gift tax value of the transferred property has been set in advance.

From Lana Fridman, CPA, CSEP, Indianapolis, IN