Q: In two articles a while ago, you discussed the tax angle of appreciated securities in charitable contributions. There is a distinction between whether the unrealized appreciation would be taxed in case of sale as ordinary income or as capital-gains income. In the first case, one can deduct only the cost, not the market value; in the second case, you advised, one can deduct the full market value, while the tax for the capital-gains appreciation falls through the cracks. But IRS Publication 17 contradicts your statement. On page 132, it says the deduction is limited to the fair market value minus ordinary income and short-term capital gains. Thus, in either case, one can deduct the full market value; it makes no difference, therefore, whether, the donor sells before giving or not. Please clarify and rectify.
A: I'm pleased to see that you got everything I said right; unfortunately, you didn't do as well understanding Publication 17. Let me quote the pertinent section on page 132: "You usually deduct gifts of capital-gain property at their fair market value. Capital-gain property is property that would result in long-term capital gain if it were sold at its fair market value on the date it was contributed. However, you must reduce the fair market value of capital-gain property by 40 percent of the appreciation in some cases."
Publication 17 then refers the reader to Publication 526 for more information. Publication 526 ("Charitable Contributions") spells out the conditions that require the taxpayer to reduce the fair market value by 40 percent of the unrealized appreciation: (a) When the property is donated to certain private nonoperating foundations; (b) when the taxpayer chooses to use the 50 percent-of-AGI limitation on charitable contributions instead of the more restrictive 30 percent limitation; or (c) the contributed property is tangible personal property put to an unrelated use by the receiving charity.
None of these conditions is a very common occurrence; and even if a large contribution puts you over the 30 percent ceiling, any unused balance may be carried forward to future years. Perhaps I should have mentioned these exceptions; but for the overwhelming majority of my readers, the columns were correct as they were written. Besides, I'm quite sure that anyone making contributions that fall under any of the exceptions would have professional tax counseling and would not be guided by my words alone.
Q: My fiancee and I both have houses. When we marry, she will sell hers and I will put mine on the rental market. She is concerned that the $70,000 profit from her house must be invested in our new house (which will cost about $225,000). But I believe her profit will be covered by her 50 percent share of the new house in the eyes of the IRS, and that she should only use part of the profit as a down payment, investing the rest. We intended to put 30 percent down on the new house, so after paying her half it still would leave her about $35,000 to use elsewhere. Who's correct?
A: I hate to get trapped in the middle of a family (even a family-to-be) difference of opinion, but I'll answer your question anyway. Fortunately, I think the answer is good news for both of you -- you're right.
There is no requirement that any of the proceeds from the sale of the old house actually be used to pay for the new house. The deferral of tax liability on the gain on sale is a paper transaction only that postpones the tax by effectively reducing the cost basis of the new house by the amount of gain on which tax is deferred.
I should point out that the deferral is not based on a comparison of the profit on the old house with the cost of the new one. The comparison is made between the selling price of the old house and your fiancee's cost of half of the new house -- about $112,500, based on your figures. I would guess, however, that she is probably covered anyway.
If your fiancee isn't happy with this answer, what can I say after I say I'm sorry? I have to call them as I see them -- and besides, she should be pleased that she doesn't have to plunk the whole $70,000 into the new house, but can invest the money that's left after paying her share of whatever down payment you agree on.