A retired grandmother with a fondness for shopping sought a way to combine her love of shopping with a desire for a tax cut. In 2010 she developed what she described as her “personal tax shelter.” She learned that a taxpayer may generally claim a charitable deduction in an amount equal to the fair market value (FMV) of the donated property. She assumed the FMV of a retail item is the dollar amount shown on the price tag when the retailer first offered the item for sale. The opportunity, as she saw it, was to find items that had been heavily discounted from the amounts shown on the original price tags. She could achieve a net tax benefit simply by buying and immediately donating the items.
For example, she might purchase for $10 in cash and “loyalty points” an item with an original retail price of $99. She would donate that item to Goodwill Industries and claim a charitable deduction of $99 on her federal tax return.
On her 2012 tax return, she claimed non-cash charitable contributions of $34,401 based on items she acquired for $2,520 in cash and $3,257 in loyalty points. The IRS selected this return for audit, and disallowed most of the claimed deduction. The taxpayer appealed to US Tax Court.
The Tax Court disagreed with the grandmother’s method of determining FMV and ruled in favor of the IRS’s disallowance of the deduction.
According to the income tax regulations, the FMV of an item is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. According to the Court, by the time the taxpayer purchased the items, the retailer had marked them down many times because no one wanted to buy them at the original higher price. Thus, the FMV was the actual price paid, NOT the original price the retailer hoped to receive.
The take-away is that you can take a deduction for non-cash donations to appropriate organizations. But, you have to follow the rules for determining the FMV.
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