Planning the Charitable Auction - A Compliance Toolkit

Planning the Charitable Auction - A Compliance Toolkit

Article posted in Tangible Personal Property on 15 July 2014| comments
audience: National Publication, Dennis Walsh, CPA | last updated: 6 June 2017
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By Dennis Walsh, CPA

Charitable auctions have stood the test of time as a great way to leverage our consumption oriented culture for the benefit of philanthropic activities.  While auctions have been traditionally held in connection with special events, in more recent years online auctions hosted by commercial vendors have increased in popularity, adding the convenience, efficiency, and cost savings of the Internet to auctions and fundraising in general.

Auctions are an effective way to:

  • Introduce a charitable mission to the public
  • Attract commercial support
  • Attract salable donations of goods and services from those unable to give cash
  • Add to special event revenue
  • Quickly grow a database of supporters

But whether an auction is live, silent, or online, there are compliance issues to become familiar with before undertaking such an endeavor.  The Internal Revenue Service (IRS) instructs its auditors that organizations are responsible for recording all fund-raising transactions and reporting on their activities.  Organizations that fail to maintain appropriate records may be subject to inadequate records notices or revocation. {1}

Beyond satisfying compliance requirements, planning an auction presents an opportunity to build goodwill with participants, donors and bidders alike, by educating them regarding the tax features of property donations and auction purchases.  This also helps project good stewardship and may add value to the auction experience. 

This article presents an overview of key charitable auction compliance issues and illustrates why donor education coupled with good advance planning will contribute significantly to a more successful auction.  With this background, and using the illustrative tools, an organization will be in a better position to meet reporting responsibilities and reap the benefits available from such an event.

Various tax law and regulatory provisions affect charitable auctions, and these laws are subject to interpretation and change.  Accordingly, competent professional advice should be obtained by organizations, sponsors, and event participants as needed.  Except as noted, all section references are to the Internal Revenue Code and Regulations.

Staffing assessment

Before putting an auction date on the calendar, the organization should consider whether it will be able to muster a strong team of volunteers to run such an event.  Most nonprofits lack the staffing capacity needed to assume the time needed to plan and adequately promote an auction without displacing other important duties.  As staff involvement increases, holding an auction may make less sense.  Weigh the expected benefits against the cost of added staff time as well as the opportunity cost of diverting resources from other activities.

Gift acceptance policy

Also consider how soliciting donations of goods and services for auction may introduce unexpected administrative costs and donor relation issues.  The organization should consider a written gift acceptance policy or revise an existing policy as necessary so that less appropriate gifts can be declined with reduced risk of negative donor reaction.  Auctions may attract unusual gifts carrying baggage that the organization isn’t equipped to deal with cost effectively, such as gifts with lack of salability, unusual storage or security issues, or significant transfer and handling costs.

Charitable solicitation licensing

Most states and the District of Columbia have some form of charitable solicitation registration for nonprofit organizations and professional fundraisers.  If an organization is not currently required to register in its state or other states in which it fundraises, including fundraising over the Internet, it should determine whether the expected income from auction related donations will tip it into covered status.

Certain states also require disclosure of the organization’s licensed status on solicitation materials and acknowledgments to donors.  Rather than avoiding these requirements, organizations should embrace the added legitimacy that public disclosure of registered status provides.

Sales taxes

Similarly, auctions involve the sale of goods and most states require nonprofits to collect sales taxes on the sale of specified goods and services in the same manner as for-profit enterprises.  However, exemptions from such requirements are common for certain fundraising activities.  It is the responsibility of the charity to determine if it must register and collect state or local taxes on event admissions or auction sales.

Risk concerns

Like other fundraising events, auctions raise risk management concerns that should be addressed prospectively.  Facilities and equipment should be set up with care and for persons of all ages and with disabilities in mind.  An individual should be assigned to watch for food or beverage spills and other hazards during the event.

Where an unusual item is donated for auction sale, the charity should assure that it really knows what it is getting before accepting such a donation and selling it at auction.  A disclaimer of warranty included on auction receipts and materials may be a helpful safeguard.

An organization should advise its insurance carrier that it will be conducting an auction so that appropriate coverage and premium is in place.  If serving alcoholic beverages, be sure the policy includes suitable coverage.  While adding a policy rider for special events is sometimes necessary, requiring the purchase of a separate policy may indicate that an insurer does not specialize in nonprofit insurance needs. 

Unrelated business income Tax (UBIT)

With certain exceptions, an organization that receives at least $1,000 per year of gross income from business activities unrelated to its exempt purposes must file IRS Form 990-T, Exempt Organization Business Income Tax Return, and will be subject to corporation income tax on its net income from such activities.

To be subject to UBIT, however, the activity must be regularly carried on.  The Regulations provide that intermittent activities, including an annual fundraising event, are not regularly carried on, and therefore do not generate UBIT. {2}

Events conducted more frequently may require closer evaluation.  For example, a continuous auction held on the organization’s website would likely meet this requirement.

Even if regularly carried on, however, there are two UBIT exceptions frequently applicable to auctions and other fundraising activities.  If an activity is conducted with substantially all volunteer labor, or the organization sells merchandise substantially all of which is donated, the activity will not be subject to UBIT. {3}  For this purpose, “substantially all” is generally regarded to mean at least 85%.

If the activity is regularly carried on and not otherwise exempt from UBIT, and the organization bundles or mixes contributed items with purchased items prior to their sale, the organization needs to track the percentage of purchased items in the bundle/mix.  If the annual sales of purchased items are more than insubstantial, then the activity is subject to UBIT. {4}

Sponsor payments

Organizations should also take care to assure that cash or the value of in-kind donations received from event sponsors is not treated as advertising revenue subject to UBIT.  To meet the requirements of a qualified sponsorship payment (QSP), event related materials may include a sponsor’s name, logo or product lines along with the sponsor’s contact information.

But the organization must not provide any type of endorsement or comparative information regarding the sponsor’s products or services. {5}  However, it is permissible to link to a sponsor’s website. {6}

Types of property

Before discussing tax rules applicable to non-cash donations, it is important to understand the meaning of certain property classifications as used by the IRS:

  • Real property – Land and land improvements, including buildings and other structures
  • Tangible personal property – Property other than real property that can be seen or touched
  • Intellectual property – Includes items such as patents, trademarks, copyrights and certain software {7}

Donation of property

Persons who donate goods for auction often ask if they are entitled to claim a market value deduction for property that has increased in value.  While this is typically true for donations of real property and securities held by a donor for more than 1 year, for a donation of tangible personal property that is put to an unrelated use by the charity, the amount of a donor's deduction will be the property’s current value, but reduced by any long-term capital gain that would have been realized if the donor had instead sold the property at fair market value at the time of the contribution. {8}

Example: Cindy donates for auction an antique chair she bought five years ago for $500.  The chair has a current appraised value of $700.  Cindy’s income tax deduction is limited to her cost of $500, consisting of the chair’s current value of $700 reduced by the amount of long-term capital gain that would be realized if she sold it instead, i.e. $700 fair market value less $200 long-term capital gain.

This rule has the unfortunate effect of limiting a deduction for a donation of tangible personal property that qualifies for long-term capital gain treatment to the lesser of the property’s current value or tax basis.  Basis will usually be the donor’s purchased cost, except where the property was acquired by gift, inheritance, or other means.

The phrase “put to an unrelated use” includes sale at auction, even though the proceeds must be used for an organization’s exempt purposes. {9}  Real estate is an infrequent charitable auction item and securities laws generally prohibit transfer of stocks, bonds, and other investments by auction. As a result, for the vast majority of auction items, this rule serves to cap a tax deduction at the amount the donor paid for the property and denies a tax benefit for any appreciation during the donor’s period of ownership.

A deduction for the donation of intellectual property is also generally limited to the lesser of fair market value or the donor’s basis.  However, a donor may be eligible to receive an annual tax deduction for up to ten years for a portion of income produced by such property while held by a charity. Accordingly, a donor contemplating such a gift should be counseled to consider donating the property to be retained by the organization instead of placing it for auction. See “Donation of Intellectual Property: What Does it Look Like?” for more about this.

Similarly, the value of any property that would produce ordinary income upon sale, such as business inventory, depreciable property used in a business, or property that would result in short-term capital gain must be reduced by the amount of ordinary income that would be realized if sold in determining the amount of a charitable deduction.  This treatment applies to donations of self-created assets as well, such as works of art and manuscripts.

Example: Stephen is an accomplished artist who paints and donates a particular work for sale at a charitable auction.  The painting has an estimated auction value of $1,000.  Stephen incurs out of pocket costs of $200 in creating his finished work.  If Stephen had instead sold the painting, he would have realized $800 of ordinary income, i.e. $1,000 value less his basis of $200.  Accordingly, his charitable contribution deduction is $200, representing the $1,000 fair market value of the painting, reduced by $800 of ordinary income that would have been realized if he had sold it instead.

As a result of such limitations, property held for personal use and that is not appreciated in value relative to a donor’s basis in the property is generally best suited for auction donation.  In some cases it may be preferable from a tax standpoint for a donor to sell an item and donate the cash proceeds instead.  Donors should be encouraged to seek planning assistance from their advisors.

Services and use of property

The donation of services is never deductible for federal income tax purposes.  This includes the donation of a pledge to perform services as well.

Example: Michelle is a family law attorney and donates an individual estate planning consultation for auction.  The value of this donation is not deductible by Michelle as a charitable contribution.

Similarly, the donation of a right to use property is treated as a donation of a partial interest in property that is not tax deductible.

Example: Eddie donates a one-week stay at his beach house for auction by Favorite Charity.  Eddie may not claim a charitable deduction for the donation of such use.

Donation related reporting

Donors of property are subject to recordkeeping and substantiation rules similar to those for donations of cash.  As for a cash donation of $250 or more, donors must likewise have a written acknowledgment from the charity for each donation of non-cash property valued at $250 or more in order to claim a charitable deduction on their income tax return. {10}

The written acknowledgment must show:

  • The name of the donee organization
  • A description of the donated property (but not the value)
  • One of the following:
    • A statement that no goods or services were provided in return for the contribution
    • A description and good faith estimate of the value of any goods and services provided in return for the contribution (certain token items may be disregarded) {11}
    • A statement that goods or services provided in return for the contribution were limited to intangible religious benefits

Refer to Exhibit 1 for a sample acknowledgment of a non-cash donation.

As a general rule, a charity should never opine on the value of donated property received.  It is a donor’s sole responsibility to substantiate the value of a non-cash contribution for income tax purposes, including obtaining a qualified appraisal when necessary.

An organization that does not acknowledge a contribution incurs no IRS penalty.  But it has been said that a thank you, like a pancake, needs to be served up fresh.  It is best practice to send a prompt thank you that includes the necessary tax information so that the donor does not need to make a later request.  This information can also be provided by email. {12}

Donations of high value

A donor of non-cash property with a value of more than $500 will need to file IRS Form 8283, Noncash Charitable Contributions, with his or her income tax return for the year of the donation. {13}

If the claimed value of donated property, including a group of similar items, is more than $5,000, with limited exceptions the donor must also obtain a qualified appraisal and Form 8283 must be signed by the appraiser and the donee organization.  In the case of art with a total claimed value of more than $20,000, a copy of the appraisal must also be attached to the donor’s tax return, including a photograph of any individual art item with a value of more than $20,000.

If the donation is tangible personal property and it is reasonable to expect that it will be put to a use unrelated to the organization’s exempt purposes, including sale at auction, the organization should check the “Yes” box in Part IV of Section B when completing the donee acknowledgment. The donor’s tax deduction will be limited as described earlier.

Since the IRS instructs that parts of Form 8283 are to be completed by the donor before requesting that the organization complete Part IV of Section B, it is helpful to alert donors to Form 8283 requirements in solicitations or event materials, but to wait for a donor request before taking any Form 8283 related actions. 

See Exhibit 4 for sample information that can be provided to auction participants regarding common tax planning and compliance issues.

Reporting sale of auction property

If a charity sells or otherwise disposes of property within 3 years of the date of donation for which it previously signed a Form 8283, it must file Form 8282, Donee Information Return, within 125 days of the disposition and provide a copy to the donor.  An exception applies to a single item having a value of $500 or less that was part of a similar group of donated items, provided that the donor signed the statement in Section B, Part II, of Form 8283 and separately identified the item.

The organization should keep a completed copy of Form 8283 on file so that it will have all of the information necessary to complete Form 8282 after an auction sale or other reportable disposition.

The sale of a donated car, boat, or airplane with a value of more than $500 must be reported to the donor on IRS Form 1098-C or an equivalent statement within 30 days of sale and must be filed with the IRS as well.  See the Form 1098-C instructions for more information.

Purchase of property at auction

Persons who purchase items at a charitable auction may claim a charitable contribution deduction to the extent the purchase price paid for an item exceeds its fair market value.  In order to establish the required donative intent, however, the purchaser must be able to show that he or she knew at the time that the value of the item was less than the amount paid. {14}  Otherwise, the IRS will treat the amount paid as fair market value and no charitable deduction will be allowable.

This is usually accomplished by distributing a catalog to participants that includes an estimated value for each item, or by indicating an estimated value on an item tag or bid sheet and providing a copy to the winning bidder.

Quid pro quo rules

Under Section 6115, charitable organizations, along with certain other exempt organizations described in Section 170(c), must provide a written disclosure to a donor who receives goods or services within the context of a fundraising event or campaign in exchange for a single payment in excess of $75. {15}  Failure to make such a quid pro quo written disclosure can result in a penalty of $10 for   each missing statement, up to a maximum of $5,000 per fundraising event. {16}

Specifically, Section 6115 requires that the written disclosure must:

  • Inform the donor that the amount of a contribution that is deductible for Federal income tax purposes is limited to the excess of the amount of any money and the value of any property contributed by the donor over the value of the goods or services provided by the organization, and
  • Provide the donor with a good faith estimate of the value of such goods or services

The organization may use any reasonable methodology in making an estimate of value, provided that it is applied in good faith.  If the organization fails to do this, it will be treated as not having met the requirements of section 6115. {17}

An exception exists for certain token donor benefits, which do not need to be disclosed: {18}

  • Goods or services that do not exceed the lesser of $106 or 2% of the contribution (de minimis value exception), or
  • The amount of the contribution is at least $53 and any goods provided consist of items bearing the charity’s name or logo (e.g. pens, mugs, T-shirts) with a cost to the charity of less than $10.60 (low-cost articles exception)

These amounts are revised annually.  See IRS Publication 1771.

The value of any donor benefits, except where not required to be disclosed, should be clearly designated on a ticket, receipt or other evidence of payment furnished to the contributor.  See Exhibit 2 for a sample quid pro quo disclosure statement for a purchased admission that includes a donor benefit. 

A question arises as to whether it is appropriate to provide a quid pro quo disclosure where a winning auction bid is less than the estimated value of an item.  The organization should provide this written disclosure to all winning bidders. 

Significantly, a donor may, but is not required to, rely on the organization’s good faith estimate of value. {20}  The fact that an amount less than a charity’s good faith estimate was paid does not prevent a purchaser from establishing from other evidence that he or she knew at the time that an amount greater than fair market value was being paid for an item.

Moreover, the burden to show that the amount paid was more than fair market value rests with the purchaser, not the organization.  In making a Section 6115 disclosure, the organization makes only a good faith estimate of value, not a competent appraisal.  By doing so, it makes no representation nor provides any assurance that a charitable deduction will be allowable. 

Refer to Exhibit 3 for a sample silent auction bid sheet that includes a quid pro quo disclosure.  See {21} for an example from the Regulations regarding a donor’s reliance on a charity’s good faith estimate of value and Section 6115 as it pertains to a charitable auction. 

Pricing donor benefits and auction items

Auctions are often accompanied by a dinner, door prizes, entertainment, or other forms of donor benefits.  Therefore, any charity conducting this type of fundraising should determine in advance the portion of a payment attributable to the purchase of admission or other privileges, and the portion solicited as a gift.

The value of donor benefits is the fair market value of the benefit provided, which may differ from the cost to the charity.

Example: Yummy Tummy Catering charges $25 per plate for a catered dinner.  The caterer agrees to provide dinner for Favorite Charity’s auction at $10 per plate.  A good faith estimate of the retail value of the dinner, $25, must be provided to those purchasing admission.  Alternatively, if Yummy Tummy donates the dinner at no cost to Favorite Charity, Favorite Charity must disclose the same good faith estimate of $25.

A donor of property to be auctioned will usually be in the best position to provide an estimate of market value and the charity should normally request this from the donor.  In the absence of a donor estimate, the charity’s good faith estimate of value should be based on the best information available.

This should not pose a problem where particular goods or services are commercially available and easily priced by reference to comparable items available for sale by Internet vendors or other sources.  For goods or services that are not generally commercially available, however, items can nevertheless be considered similar or comparable even though they do not have the unique qualities of the item being valued. {19}

Financial accounting/Form 990 distinctions

The donation of property or a right to receive services followed by a fundraising sale of such items present certain financial accounting and IRS Form 990 reporting issues that nonprofit organization finance staff and independent accountants need to be familiar with.

GAAP issues

Under generally accepted accounting principles (GAAP), the donation of property, broadly defined, is recognized as revenue and recorded at fair value at the time of contribution.  When subsequently sold at auction, because such gifts in kind are, in substance, part of the same transaction, the difference between the amount received on sale and the fair value when originally contributed should be recognized as an adjustment to the original contribution. {22}

Some organizations choose not to recognize the donation of property to be auctioned and instead record only the amount realized upon sale as contribution income. While this accounting convenience results in the same net contribution income when a donation and sale occur in the same reporting period, if a reporting period ends between the dates of contribution and auction, this practice would result in the omission of contribution income and inventory from the financial statements.

Services donated for auction are not recognized as revenue for financial accounting purposes because, even if they meet the specialized skills requirement and are provided by individuals possessing such skills, they would not meet the requirement that they would typically need to be purchased if not provided by donation. {23}

For example, if an attorney donates an estate planning consultation for auction, the fair value of the consultation is not recorded as contribution income, even though such services involve specialized skills and are provided by someone possessing those skills.  The services are not in the nature of those the organization would normally need to purchase.  Thus, the attorney’s pledge to perform the consultation is not recognized as contribution income at the time of donation.  Rather, the amount realized upon auction sale will be recognized as contribution income at such time.

Form 990 issues

While an organization may generally follow its GAAP reporting of contributions for Form 990 reporting as well, there are several important distinctions relating to donations of property for fundraising sale.

In contrast to GAAP treatment as a single contribution, Property donated for fundraising and its subsequent sale are reported as separate and distinct transactions on Form 990.  The difference between the amount realized from the sale of property at auction and the fair value at the time of donation results in a separately reported gain or loss from fundraising events.

Donation of the use of materials, equipment, or facilities is not recognized as income.  Additionally, the donation of services is never recognized as income for Form 990 reporting.  Rather, the proceeds from the subsequent auction of these types of items are recognized as income from fundraising events in the period sold.

See {24} for two helpful examples from the Form 990 instructions illustrating the reporting of auction related transactions.  A sample checklist of auction related compliance items, including Form 990 related reporting, is contained in Exhibit 5.

Helpful IRS resources

The following IRS publications and forms are available online at www.irs.gov.

  • Pub. 526, Charitable Contributions
  • Pub. 561, Determining the Value of Donated Property
  • Pub. 1771, Charitable Contributions - Substantiation and Disclosure Requirements
  • Form 8282, Donee Information Return
  • Form 8283, Noncash Charitable Contributions

Thanks to Adam P. Cohen, CPA, West Hartford, CT Mig Murphy Sistrom, CPA, Durham, NC, and Pamela E. Davis, CEO, ANI/RRG, Santa Cruz, CA for their help in development of the article.

References

{1} IRM 4.76.51.4(12-13-2013)

{2} Treas. Reg. § 1.513-1(c)(2)(iii)

{3} IRC § 513(a)

{4} IRM 4.76.51.9 (12-13-2013)

{5} IRC § 513(i)(2)(A) 

{6} Treas. Reg. § 1.513-4(f), Example 11

{7} IRC § 170(e)(1)(B)(iii), except for software described in IRC § 197(e)(3)(A)(I), consisting essentially of purchased “off the shelf” software

{8} Treas. Reg. § 1.170A-1(c)(1), IRC § 170(e)(1)(B)(i)

{9} Treas. Reg. § 1.170A-4(b)(3)(iii) 

{10} IRC § 170(f)(8)(A)

{11} See IRS Publication 1771 for exceptions and current year limits

{12} IRS Publication 1771

{13} IRC § 170(f)(11)(C), IRC § 170(f)(11)(E), IRS Form 8283 instructions

{14} Treas. Reg. § 1.170A-1(h)(1)(i)

{15} IRC § 6115

{16} IRC § 6714

{17} Treas. Reg. § 1.6115-1(a)(1)

{18} Treas. Reg. § 1.170A-13(f)(8)(i), Rev. Proc. 90-12, see IRS Publication 1771 for current year limits

{19} Treas. Reg. § 1.6115-1(2)

{20} Treas. Reg. § 1.170A-1(h)(4)

{21} Treas. Reg. § 1.170A-1(h)(5):  Example 2. Treatment of good faith estimate at auction as the fair market value. Taxpayer attends an auction held by Charity C, an organization described in section 170(c). Prior to the auction, C publishes a catalog that meets the requirements for a written disclosure statement under section 6115(a) (including C's good faith estimate of the value of items that will be available for bidding). A representative of C gives a copy of the catalog to each individual (including Taxpayer) who attends the auction. Taxpayer notes that in the catalog C's estimate of the value of a vase is $100. Taxpayer has no reason to doubt the accuracy of this estimate. Taxpayer successfully bids and pays $500 for the vase. Because Taxpayer knew, prior to making her payment, that the estimate in the catalog was less than the amount of her payment, Taxpayer satisfies the requirement of paragraph (h)(1)(i) of this section. Because Taxpayer makes a payment in an amount that exceeds that estimate, Taxpayer satisfies the requirements of paragraph (h)(1)(ii) of this section. Taxpayer may treat C's estimate of the value of the vase as its fair market value in determining the amount of her charitable contribution deduction.

{22} FASB Accounting Standards Codification (ASC) 958-605-25-20

{23} FASB Accounting Standards Codification (ASC) 958-605-25-16(b)

{24} Examples from IRS Form 990 instructions for Part VIII, Statement of Revenue

Example 1.  A hotel in a city's entertainment district donates 100 “right to use” certificates covering 15 hotel rooms a night to disaster relief organization B.  B then uses these certificates as emergency housing in furtherance of its exempt purposes.  B should not report the value of this contribution on line 1 {contribution income} (or on any other line in Part VIII) {Statement of Revenue}, because this is a donation of services and use of facilities to B.  Similarly, if B were to auction off the certificates as part of a fundraising event, B should not report the value of the contributed certificates on line 1 (or on any other line in Part VIII).  Rather, it should report gross income from the auction on Part VIII, line 8a {income from fundraising events}.

Example 2.  Organization C purchases 100 “right to use” certificates (as described in Example 1) from the hotel, then contributes them to disaster relief organization B and designates that they be used for disaster relief purposes.  B should report the fair market value (FMV) of these certificates on line 1.  If B were to auction off the certificates as part of a fundraising event, then use the proceeds for disaster relief purposes, B should report the gross income from the auction on Part VIII, line 8a, report the FMV of the contributed certificates in line 8b, and report the difference between lines 8a and 8b on line 8c.

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