The Tax Law of Charitable Giving. Bruce R. Hopkins

purpose (related use) and a use that is not related to the donee organization's tax-exempt purpose (unrelated use).¹²

The extent to which a contribution of property is deductible for federal income tax purposes is dependent upon the interplay of these factors, plus the value of the property,¹³ the percentage limitations,¹⁴ and compliance with the substantiation and appraisal rules.¹⁵

§ 3.3 CONTRIBUTIONS OF LONG-TERM CAPITAL GAIN PROPERTY IN GENERAL

When a donor makes a contribution of long-term capital gain property to a public charitable organization, the charitable deduction is generally based on the full fair market value of the property.¹⁶ There generally is no need for the donor to recognize the capital gain element. This rule is also generally applicable when the donee is a governmental entity.

The rule is not applicable when the donee is a charitable organization other than a public charitable organization. In that instance, the charitable deduction generally is confined to the donor's basis in the property.¹⁷

§ 3.4 CONTRIBUTIONS OF ORDINARY INCOME PROPERTY

      The federal tax law places limitations on the deductibility of property that, if sold, would give rise to gain that is not long-term capital gain. This type of property, which is termed ordinary income property, includes short-term capital gain property.

      Federal tax law provides a rule requiring the modification of what would otherwise be the charitable deduction for a contribution of property that is ordinary income property.

(a) Definition of Ordinary Income Property

Ordinary income property is property that has appreciated in value, any portion of the gain on which would give rise to ordinary income (or short-term capital gain) if the property had been sold by the donor at its fair market value at the time of the charitable gift. Ordinary income is income that is not long-term capital gain. For these purposes, ordinary income and short-term capital gain are regarded as the same. Thus, ordinary income property is property that, if sold at its fair market value by the donor at the time of its contribution to a charitable organization, would generate a gain that is not long-term capital gain.¹⁸

      Examples of ordinary income property are:

       Property held by the donor primarily for sale to customers in the ordinary course of a trade or business (inventory)¹⁹

       A capital asset held for a period of time that is less than the period required to cause the property to become long-term capital gain property (short-term capital gain property)

       A work of art created by the donor

       A manuscript created by the donor

       Letters and memoranda prepared by or for the donor

       Stock acquired in a nontaxable transaction that, if sold, would generate ordinary income²⁰

       Stock in a collapsible corporation that, if sold, would generate ordinary income²¹

       Stock in certain foreign corporations that, if sold, would generate ordinary income²²

       Property used in a trade or business,²³ treated as a capital asset, if gain would have been recognized, upon sale of the property by the donor at its fair market value at the time of the contribution, as ordinary income by reason of the application of recapture rules²⁴

The term ordinary income property does not include an income interest in respect of which a federal income tax charitable contribution deduction is allowed.²⁵

It is the position of the IRS that, when individuals purchase items with the intent of retaining them for the requisite capital gain holding period²⁶ and thereafter donating them to a charitable organization for the purpose of generating a charitable contribution deduction (in an amount greater than the acquisition price), the individuals are engaged in a charitable donation venture.²⁷ The consequence of this view is that the properties held for contribution purposes are items of inventory of the venture and thus are forms of ordinary income property.²⁸ This position, however, is being rejected in the courts.²⁹

(b) Deduction Reduction Rules

Often, as noted, the rule for the deduction arising from a gift of property to a charitable organization is that the amount of the deduction is equal to the amount of the fair market value of the property at the time of the gift.³⁰ In the case of a charitable gift of ordinary income property, however, the amount of the charitable contribution for the gift of the property must be reduced by the amount of gain that would have been recognized as gain, which is not long-term capital gain, if the property had been sold by the donor at its fair market value, determined at the time of the contribution to the charitable organization.³¹ The amount of gain that is taken into account in making this reduction is sometimes termed the ordinary income element.

Consequently, this deduction reduction rule basically means that a donor's deduction for a contribution of an item of ordinary income property to a charitable organization is confined to the donor's basis in the property. The amount that is deductible is the fair market value of the property, reduced by the amount that is equal to the ordinary income element.³² In one case, a company that contributed its film library to a charitable organization was advised by the IRS that its charitable contribution deduction was zero, in that the library was akin to letters and memoranda and, thus, was not a capital asset. Because the costs associated with establishing the library were expensed as incurred, the basis in the property was zero. The value of the property contributed had to be reduced by its full amount.³³

      This rule applies:

       Irrespective of whether the donor is an individual or a corporation

       Irrespective of the tax classification of the charitable organization that is the donee (for example, public or private charity)³⁴

       Irrespective of whether the