Updated December 29, 2005
Dealing with the New Rules for Charitable Donations of Autos

The IRS recently issued guidance on the new-for-2005 rules for charitable gifts of automobiles [Notice 2005-44, 2005-25 IRB]. When a taxpayer donates property to a charity, the taxpayer can generally deduct the fair market value of the property at the time of the donation. However, under new rules created by the American Jobs Creation Act of 2004:
No deduction is allowed for a donation of a motor vehicle (including boats and airplanes) with a claimed value of more than $500 unless the charity provides the donor with a contemporaneous written acknowledgment that meets certain requirements. A copy of the acknowledgment must be included with the donor’s tax return on which the deduction is claimed.
If a charity sells the vehicle, the donor’s deduction is generally limited to the gross proceeds received from the sale (typically less, maybe far less, than the vehicle’s “fair market value”). However, the Internal Revenue Code provides two exceptions: The gross proceeds limitation does not apply (1) when there has been “significant intervening use” of the vehicle by the charity before the sale or (2) when the charity makes “material improvements” to the vehicle [IRC Sec. 170(f)(12)(A)(ii)]. In its new guidance, the IRS creates a third exception. The gross proceeds limitation also may not apply when there is a bargain sale or a gift of the vehicle by the charity to a needy individual. To qualify for this exception, the sale or gift must directly advance a charitable purpose of the charity to help the poor, distressed or underprivileged in need of a means of transportation.
The new rules will affect both your individual clients who donate automobiles and your nonprofit clients that operate car donation programs. For example, individual donors who want to maximize their deductions will need to select a charity that qualifies for one of the exceptions to the new deduction limitation. And all donors claiming more than a $500 deduction must comply with the new acknowledgement requirement or forfeit their deductions. Charities face penalties unless they provide their donors with proper acknowledgements and provide the IRS with required information reports.

In its new guidance, the IRS says that all acknowledgements required for over-$500 deductions must include the following information:
the name and taxpayer identification number of the donor,
the vehicle identification number, and the date of the donation.
Additional information is required depending on what happens after the vehicle is donated. For example, if the vehicle is sold by the charity and none of the three exceptions applies, the acknowledgement must also contain:
the date the vehicle was sold, a certification that the vehicle was sold in an arms’ length transaction between unrelated parties, a statement of the gross proceeds from the sale, and a statement that the deductible amount may not exceed the amount of the gross proceeds.
According to the IRS, a “significant intervening use” means that a charity must actually use the donated vehicle to substantially further the organization’s regularly conducted activities. Incidental use by an organization is not a significant intervening use.

The IRS says that a “material improvement” includes a major repair or improvement that improves the condition of the vehicle in a manner that significantly increases the value. Cleaning, minor repairs, and routine maintenance are not considered material improvements.

A charity may provide the required acknowledgment to a donor in any “reasonable” manner. A charity must provide the IRS with the same information given to the donor in the acknowledgement [IRC Sec. 170(f)(12)(D)]. The IRS has issued new Form 1098-C for this reporting requirement. The IRS says that a charity may use a copy of the Form 1098-C to provide the required acknowledgement to the donor.

Beware of questionable deductions
IRS announced on Tuesday 12/20/05 that the agency will not recognize certain deductions that taxpayers may be claiming relative to auction sales of donated vehicles. More specifically, IRS is concerned about a practice in which some charities have sold donated vehicles at auction and claimed that the sales are to needy individuals at prices significantly below market value. The charities then claim that the below-market sales triggers an exception to the rule that a taxpayer’s charitable donation is limited to the amount for which a vehicle sells.

Bottom line: if a charity sells a donated vehicle at auction, the Service WILL NOT accept as substantiation an acknowledgement from the charity stating that the vehicle is to be transferred to a needy individual for significantly below market value (Form 1098-C, box 5b). In such cases, the donor may claim a deduction of more than $500 ONLY if the gross proceeds from the sale exceed that amount and the donor substantiates the contribution with an acknowledgment from the charity that indicates the gross proceeds from the sale (Form 1098-C, box 4c).

The IRS reminds taxpayers that they must obtain a charity’s written acknowledgment of their vehicle donation before they claim a deduction for the donation. For deductions of more than $500, the taxpayer is required to attach the acknowledgment to the taxpayer’s return for the year of the donation.

Questions have arisen as to whether the charity must sell the vehicle in 2005 for the donor to receive a deduction for 2005. The charity does not need to sell the vehicle in 2005. A taxpayer can take a charitable contribution deduction only for the year the vehicle is transferred to the charity, even if the vehicle is not sold by the charity until a later year. Only taxpayers who itemize their deductions can take a charitable contribution deduction. If the taxpayer receives a written acknowledgment after filing the tax return for the year of the donation, the taxpayer may, after receiving the acknowledgment, file an amended return for that year and claim the deduction on the amended return.

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