Sweeping New Tax Rules For Charitable Donations

The new Pension Protection Act of 2006 (PPA) completely revamps the tax rules for deducting charitable donations. The following is a brief summary of some of the key changes for individual taxpayers.

Cash Contributions
The new law tightens the rules for substantiating charitable donations of cash or cash equivalents. Effective for contributions in tax years beginning after August 17, 2006 (2007 for calendar-year taxpayers), no deduction is allowed for any contribution of cash, check or other monetary gift unless the taxpayer can show a bank record or written communication from the charity indicating:

• the amount of the contribution,
• the date the contribution was made and
• the name of the charitable organization.

Clothing And Household Items
Deductions for clothing and household goods will be denied unless the items are in “good condition.” This includes such household items as furniture, electronics, appliances, furnishings, linens and the like. This change is effective for donations made after August 17, 2006. Under a special exception, a taxpayer can claim a deduction for a single item that has been appraised for more than $500, even if it’s not necessarily in good condition.

Personal Property
Normally, an individual may deduct the fair-market value of donated tangible personal property if the property would have qualified for long-term capital gain if it had been sold. However, the deduction is reduced to the amount of the property’s basis if the charity does not use the property to further its tax-exempt purpose.

Under the new law, deductions for tangible personal property valued at more than $5,000 may be reduced if the property is disposed of by the charity in the year of the contribution. Similarly, the tax benefits for donations based on fair-market value must be recaptured if the organization disposes of the property after the year of contribution, but within three years of the contribution date. These changes are effective for donations made after September 1, 2006.

Fractional Interests
Assuming certain requirements are met, a taxpayer may claim a deduction for donating a “fractional interest” in property. Among other technical changes, the new law requires recapture of tax benefits for such deductions if the taxpayer fails to contribute his or her entire interest in the property within ten years or if the charity does not take “substantial physical possession” of the item within the ten-year period. The provision applies to donations made after August 17, 2006.

Similar provisions in the new law apply to the estate and gift taxation of fractional interests.

Conservation Easements
Generally, deductions for contributions of property are limited to 30 percent of adjusted gross income (AGI). Any excess may be carried over for five years.

This includes gifts of “conservation easements” designed to preserve or protect land, natural habitats or historic structures. The PPA raises the deduction limit for qualified conservation easements to 50 percent of AGI (100 percent for qualified farmers and ranchers) if certain conditions are met. Furthermore, the carryover period is extended to 15 years.

These favorable tax changes are also effective only for the 2006 and 2007 tax years.

On the downside, the new law tightens the definition of “certified historic structures” eligible for charitable deductions. It also reduces deductions for such property if the rehabilitation tax credit has been claimed.

This is only a summary of several changes in the PPA. It is important to coordinate all the new law provisions and the existing rules.

These articles are reprinted with permission from The Family Business Report sponsored by the Goering Center at the University of Cincinnati College of Business Administration.