Bigger the gift - bigger the scrutiny

Not every attorney will agree with my approach. Here is the theory: the bigger the gift, the more precautions you take. (The question you are supposed to ask is: aren't the precautions the same for all size gifts - at least ones over $500 or $5,000?)

Hear this story and you'll understand.

I received a call from a colleague the other day about accepting a work of art. A university but one that does not have a museum or an art program or even art classes. But, it does have places where it displays art and has regularly accepted works of art as donations in the past (presumably professing a "related use" program so that the donors were entitled to full fair market value deductions for their gifts).

Sounds like they are good to go as far as "related use" (will be discussed below), the first hurdle in accepting a work of art. One fact I left out though: the proposed art donation involves very, very valuable works of art - relatively famous, too. I don't want to give any more details because this one is still in the works. Let's just say a real value of multiple millions - we'll just call it a "Picasso" to give us some perspective.

When the conversation started, I knew enough about the institution to assume that related use would not be a problem and that they could move on towards other complications in dealing with a proposed art gift of any magnitude (which are many).

But, when he said it was a Picasso, I started churning in my mind. And, of course, he also had an art museum expert telling him that it wasn't related use to this institution. (Topic for another blog post - non-lawyers playing lawyer and reaching the wrong conclusions.)

Well, here are some of the IRS private letter rulings on related use mentioned in Tax Economics of Charitable Giving:

Porcelain art related to retirement home's exempt purpose because the objects enhanced the residents' living environment. PLRs 8143029 and 8247062.

Wildlife etchings on public display in state office buildings, ok, too. PLR 8301056.

Displayed stamp collection in University's art gallery plus use in school's art program, ok, too. PLR 8208059

This university in question has some sort of art appreciation or therapeutic thing (not a formal program but something).

Of course, the IRS tells us to rely on private letter rulings at your own risk (like beaches without lifeguards) - the IRS always has the option of ruling any which way they want when they get to your case.

If this had been a run of the mill gift of less than a million, I might have made a different suggestion. But, since this was a "Picasso", I couldn't shake the thought of the IRS art panel reviewing the deduction and somehow this issue of related use coming up.

My suggestion was to hire the best attorney in the area of art contributions you can find before moving forward with the donor. Besides, related use is only an initial issue. Even more daunting is the qualified appraisal (subject of an upcoming blog post). Anything less than having the best counsel reviewing the entire proposed gift would be foolish in this case. Not with a multi-million dollar donor involved and several sticky issues that really could come back to haunt everyone (especially the charity).

The point of this post is this: size and magnitude of a gift makes a big difference in how I advise someone. This institution clearly never ran into issues with accepting art in the past but they also have never had anything of this magnitude. Millions of dollars are at stake in charitable deductions and even though the IRS has never taken issue with art contributions to this institution in the past, nothing is stopping them from taking a hard line this time - especially since it can easily be described as a stretch to claim related use. The private letter rulings seem to point towards this stretch being within reason but you better have an attorney on your side who has been through this before guiding you.

I hope to post updates on this one as it moves forward if my colleague reports back on how it is proceeding.

Just a reminder about what the "related use" rule is (according to the IRS):

A donor is only entitled to a deduction of the "cost basis" (usually the original purchase price) for gifts of "tangible personal property" (i.e. art or collectibles) when "use by the donee is unrelated to the purpose or function constituting the basis for its exemption under section 501." IRS Code Sec. 170(e)(1)(B)(i).

And, let's not forget IRS Code Sec. 170(e)(7) which effectively says that if the charity sells the "related use" tangible personal property gift within three years of the contribution, the gift is retroactively presumed to be "unrelated use" and your donor retroactively loses his or her deduction over the cost basis.

Here are the relevant IRS Regulations on related use, Reg. 1.170A-4(b)(3)(i)and (ii):

(3) Unrelated use--(i) In general. The term unrelated use means a use which is unrelated to the purpose or function constituting the basis of the charitable organization's exemption under section 501 or, in the case of a contribution of property to a governmental unit, the use of such property by such unit for other than exclusively public purposes. For example, if a painting contributed to an educational institution is used by that organization for educational purposes by being placed in its library for display and study by art students, the use is not an unrelated use; but if the painting is sold and the proceeds used by the organization for educational purposes, the use of the property is an unrelated use. If furnishings contributed to a charitable organization are used by it in its offices and buildings in the course of carrying out its functions, the use of the property is not an unrelated use. If a set or collection of items of tangible personal property is contributed to a charitable organization or governmental unit, the use of the set or collection is not an unrelated use if the donee sells or otherwise disposes of only an insubstantial portion of the set or collection. The use by a trust of tangible personal property contributed to it for the benefit of a charitable organization is an unrelated use if the use by the trust is one which would have been unrelated if made by the charitable organization.

(ii) Proof of use. For purposes of applying subparagraph (2)(ii) of this paragraph, a taxpayer who makes a charitable contribution of tangible personal property to or for the use of a charitable organization or governmental unit may treat such property as not being put to an unrelated use by the donee if:

(a) He establishes that the property is not in fact put to an unrelated use by the donee, or

(b) At the time of the contribution or at the time the contribution is treated as made, it is reasonable to anticipate that the property will not be put to an unrelated use by the donee. In the case of a contribution of tangible personal property to or for the use of a museum, if the object donated is of a general type normally retained by such museum or other museums for museum purposes, it will be reasonable for the donor to anticipate, unless he has actual knowledge to the contrary, that the object will not be put to an unrelated use by the donee, whether or not the object is later sold or exchanged by the donee.