Nonprofit entities are obligated to evaluate property they receive through donations, which impacts the finances of donors by determining the value of their charitable tax deductions. The fair market value (FMV) of property is the gold standard for assessing its financial value. However, there is not a simple strategy for calculating fair market donation values across all property types.
How the IRS Defines FMV
Simply put, the IRS considers the FMV of property to be the financial return it would generate if sold on the open market, including depreciation from use and obsoletion, as well as restrictions that limit use. For example, if a donor stipulates that farmland given to a nonprofit must be used for commercial development, the value of the land is subject to conditions in the commercial real estate market, not factors influencing the market for agricultural acreage.
Further complicating the relationship of donations and taxes is the fact that donation values must be calculated to reflect the range of factors that define property value, including an assessment of the property’s “desirability”, as well as the “scarcity”.
With that said, the IRS aims to make determining values simpler by basing FMV on three factors that are relevant to most types of donated property a nonprofit receives:
1. Cost / Selling Price
How much the donor paid for the property, or how much the receiving organization earned from liquidating it, is a strong determinant of FMV. However, because market conditions inevitably change, the property’s initial cost or selling price retains less meaning over time.
2. Comparable Sales
Value is also calculated based on proceeds from the sale of similar properties. Five factors define comparability: similarity between the properties, proximity of sales to the date of valuation, formal circumstances surrounding sales, and market conditions at the time sales transpired.
3. Replacement Cost
A third factor in determining donation values is how much a donated property would cost to replace. Replacement cost is most reflective of FMV when the open market supply and demand for a property are nearly equivalent.
Inventory Donations and Taxes
The deduction for donated business inventory is the lesser of the inventory’s FMV on the day of the donation or the “basis” of the inventory, which is any cost resulting from the business buying or creating opening inventory for the year. If the donated inventory is not included in the cost of opening inventory, its value is zero, which precludes the donor from claiming a charitable tax deduction. If so, the cost is instead added to the cost of products sold during the current year, with the inventory’s sale value recorded as zero.
An exception to the standard appraisal of inventory donations is also one of the most popular and sought-after types of donations: foodstuffs. To yield a tax deduction, donated food inventory must be given to a qualified organization, made for human consumption, and considered wholesome, regardless of whether it is marketable on the donation date. The business may receive a deduction of up to one-half of the sale value of the inventory on the donation date.
Even when a nonprofit organization cannot claim tax deductions for particular donations (e.g., non-cash and in-kind donations), it may still be required to list the donations on financial statements. As with donations that are deductible, donation values for non-deductible items should be commensurate with their current FMV, which is comparable to what a nonprofit would pay a third party to purchase the items instead of receiving them free of charge. For more tax advice and accounting for nonprofit organizations, contact the experienced CPA’s at Maxwell Locke & Ritter.