Ordinary Income Property refers to specific types of property whose sale at fair market value on the date of the contribution would result in ordinary income or in a short-term capital gain for the contributor. This typically includes inventory, works of art or manuscripts created by the donor, and capital assets held for one year or less.
Categories of Ordinary Income Property
Inventory
Inventory encompasses all goods and materials a business holds for the purpose of resale. For charitable giving, inventory is considered ordinary income property if sold, which can affect the donor’s tax treatments.
Created Works
This category includes works of art, manuscripts, and other intellectual properties created by the donor. When these items are donated, they are still considered ordinary income property due to the nature of their creation being tied to the donor’s income-generating activities.
Short-term Capital Assets
Short-term capital assets are those that have been held for one year or less. If these assets are contributed to charity, their sale would normally result in a short-term capital gain, falling under the classification of ordinary income property.
Tax Treatment and Fair Market Value
Determination of Fair Market Value
Fair Market Value (FMV) is the price at which property would change hands between a willing buyer and a willing seller. The donor must substantiate this value through appraisal or other means as required by tax law.
Ordinary Income and Short-term Capital Gains
When ordinary income property is donated, the tax deduction is generally limited to the lesser of the FMV or the donor’s basis in the property. This limitation arises because the property’s sale at FMV would otherwise result in ordinary income or a short-term capital gain.
Examples
Example 1: Inventory Donation
A bookstore donates unsold books to a local charity. The books represent inventory. If sold, proceeds would have been treated as ordinary income; therefore, the donation is subject to ordinary income property rules.
Example 2: Created Artwork
An artist donates a painting to a museum. The painting is considered ordinary income property because it was created by the artist, and would have generated ordinary income had it been sold.
Example 3: Short-term Capital Asset Donation
An individual donates stocks held for six months to a charitable organization. The stocks are short-term capital assets and any sale would result in a short-term capital gain, thus classified as ordinary income property.
Historical Context
The concept of ordinary income property in charitable contributions has been shaped by tax laws aimed at ensuring that deductions on donated property closely align with the donor’s actual economic cost—or basis—rather than the potentially higher fair market value, thus preventing inflated tax deductions.
Applicability and Special Considerations
Donor Basis Limitation
When donating ordinary income property, the donor’s tax deduction is limited to the lower of the FMV of the property or their adjusted basis in it.
Record-keeping Requirements
Substantiating the donation typically requires documentation, including appraisals for items valued over certain thresholds, receipts from the charitable organization, and proof of the donor’s basis in the property.
Charitable Organization Use
Certain exceptions and special considerations apply if the donated property is used by the charitable organization in a manner related to its tax-exempt purpose.
Related Terms
- Fair Market Value (FMV): The estimated value of a property based on what a willing buyer would pay and what a willing seller would accept in an open market.
- Capital Gain: An increase in the value of a capital asset that gives it a higher worth than the purchase price.
- Adjusted Basis: The original cost of a property, with adjustments for various factors like improvements or depreciation.
Frequently Asked Questions (FAQs)
What happens if I donate capital assets held longer than one year?
Such assets are typically considered long-term capital gain property, allowing a donor to deduct the full fair market value, differing from ordinary income property rules.
How is the fair market value determined?
FMV is determined through appraisal or comparable sales, considering the condition and market of the property at the time of the donation.
Are there any limits on the deduction for charitable contributions?
Yes, there are percentage limitations on charitable contributions relative to the donor’s income, which vary based on the type of property and the type of charity.
References
- “Tax Reform Act of 1986”
- Internal Revenue Service (IRS) Publication 526 on Charitable Contributions
- “Fair Market Value Determination and Substantiation of Noncash Contributions” - Financial Management Journal
Summary
Ordinary Income Property encompasses assets whose sale at fair market value would result in ordinary income or short-term capital gains. The tax deduction is limited to the lower of the FMV or the donor’s adjusted basis to align the donor’s tax benefit with their economic cost. This classification includes inventory, works of art created by the donor, and short-term capital assets, with special record-keeping and valuation requirements applied.
