Nonprofits often struggle with valuing noncash and in-kind donations, including the value of houses or other buildings. Whether for record-keeping purposes or when helping donors understand proper valuation for their charitable tax deductions, the task isn’t easy.
Although the amount that a donor can deduct generally is based on the donation’s fair market value (FMV), there’s no single formula for calculating FMV for every type of gift. (Note: This article focuses on valuing gifts for tax purposes rather than financial accounting purposes.)
The IRS defines FMV as the price that property would sell for on the open market. (A donor can’t claim a deduction for the contribution of services.) For example, if a donor contributes used clothes, the FMV would be the price that typical buyers actually pay for clothes of the same age, condition, style and use.
If the property is subject to any type of restriction on use, the FMV must reflect that restriction. Say a donor contributes land to your not-for-profit and restricts its use to agricultural purposes. The land must be valued for agricultural purposes, even though it would have a higher FMV for nonagricultural purposes.
Ultimately, FMV must consider all facts and circumstances connected with the property, such as its desirability, use and scarcity.
3 FMV factors
According to the IRS, there are three particularly relevant FMV factors:
1. Cost or selling price. The cost of the item to the donor or the actual selling price received by your organization may be the best indication of the item’s FMV. Because market conditions can change, though, the cost or price becomes less important the further in time the purchase or sale was from the date of contribution.
For example, you may have paid $2,500 for a top-of-the-line computer in 2005. But that computer certainly isn’t worth $2,500 in 2012 because it’s no longer top of the line. It may still have some value, though.
A documented arm’s-length offer to buy the property close to the contribution date may help prove its value to the IRS. The offer must have been made by an independent, unrelated party willing and able to complete the transaction.
2. Comparable sales. The sales price of a property similar to the donated property often is critical in determining FMV. The weight that the IRS gives to a comparable sale depends on:
- The degree of similarity between the property sold and the donated property,
- The time of the sale,
- The circumstances of the sale (was it at arm’s length?), and
- The market conditions.
The degree of similarity must be close enough that reasonably well-informed buyers or sellers of the donated property would have considered that selling price. The greater the number of similar sales for comparable selling prices, the stronger the evidence of the FMV.
It’s important, though, that the transactions take place in an open market. If the sales were made in a market that was artificially supported or stimulated, they might not be representative or indicative of the FMV. For example, liquidation sale prices typically don’t indicate FMV.
3. Replacement cost. FMV should consider the cost of buying, building or manufacturing property akin to the donated item, but the replacement cost must have a reasonable relationship with the FMV. And if the supply of the donated property is more or less than the demand for it, the replacement cost becomes less important to FMV.
Gifts of Inventory
If a business contributes inventory, it can deduct the smaller of its FMV on the day of the contribution or the inventory’s basis. (The basis of donated inventory is any cost incurred for the inventory in an earlier year that the business would otherwise include in its opening inventory for the year of the contribution.) If the cost of donated inventory isn’t included in the opening inventory, its basis is zero and the business can’t claim a deduction.
Inventory that may receive a better valuation than other inventory includes that which is used solely for the care of the ill, needy or infants; book inventory or food for public schools; and scientific property for research. The special provisions for books, food, and inventory for the care of the ill, needy or infants expired at the end of 2011, but have been extended retroactively in the past. (For the latest, check with your CPA.) In addition, certain industries, such as the pharmaceutical industry, have specific standards for valuing donated inventory.
An Important Reminder
Even if a donor can’t deduct a noncash or in-kind donation (usually a piece of tangible property or property rights), you may need to record the donation on your financial statements. Recognize such donations (including the donation of services) at their fair value, or what it would cost if your not-for-profit were to buy the donation outright from an unrelated third party.
For additional information on our nonprofit services, please contact Jon Moll, CPA at 302.225.0600 or click here to email Jon. In a brief consultation he can assess your situation and determine the best way to proceed