What in the world are you going to do with that worthless piece of junk in your driveway? It used to be your pride and joy when it was bright, shiny, and running well. But, sadly, it's now turned into nothing more than a perch for the pigeons.

OK, it might not be quite that bad. But many of you have a clunker in the driveway or in storage and can't figure out what to do with it. Then you hear see an ad in the newspaper that tells you about saving tax dollars by donating the vehicle to some worthy charitable organization. Is that the right move for you? Let's take a look.

Itemized deductions
This type of charitable contribution is an itemized deduction. If you normally itemize your deductions (including medical, interest, taxes, charity, and miscellaneous deductions), then the charitable contribution deduction that you will receive on your donation will certainly increase your deductions and reduce your taxes.

But many people don't itemize their deductions. Don't forget that you receive a standard deduction, which for 2002 is $7,850 for joint returns, $4,700 for singles, and $6,900 for Head of Household filers. So if your itemized deductions are less than your standard deduction, claiming the standard deduction is your best tax choice. If the contribution of your old vehicle doesn't throw you above the standard deduction, that contribution won't be beneficial to you from a tax standpoint.

A percentage game
Remember that taxes are a percentage game. If you're in the 27% federal tax bracket, you'll get tax relief of $27 for each $100 your donate. Assuming that you're allowed to itemize your deductions, and the contribution of the auto will help you reduce your taxes, how many tax dollars will you save? Let's look at an example.

Linda is in the 27% tax bracket and itemizes her deductions. She decides to donate her old vehicle to charity. Checking around the Internet, Linda found that vehicles similar to hers have been selling for as high as $4,000. Therefore, Linda figures that donating the car will save her $1,080 in taxes.

Which begs the question: Why in the world would Linda not just sell the vehicle for $4,000 and put that money in her pocket (tax-free)? There are certainly a number of valid reasons. Linda might really care about the charity to which she is making the contribution. Perhaps Linda doesn't have the time to sell the car herself. It's possible that she doesn't want to dicker with the auto dealer about the value of her car as a trade-in if she is shopping for a replacement vehicle. The darn thing might just not be running, and she simply wants the charity tow truck to take it away.

Or she might be inflating the value of the vehicle in order to get the most money out of the car (at Uncle Sam's expense) hassle-free.

Valuation of the vehicle
The law is clear on this point: The deduction is only valid if you apply the correct fair market value (FMV) to the vehicle. Let's assume that Linda's car is really a piece of junk. It doesn't run because the engine has been torn apart. The paint is worn. The interior is shredded. She already spoke to a few people who wouldn't give her even $500 for it.

But Linda should still be OK, since she went on the Internet and found that the value of a similar vehicle was actually $4,000, right? Wrong! Uncle Sam is aware of this scam, and has pulled many of these tax returns for examination. Knowing that most folks would be better off selling the vehicle and taking the cash, the IRS is curious as to how the FMV of the vehicle was determined.

The charity picking up the vehicle will provide a value, right? Wrong again. It's not their job or obligation. It's your job to determine a valuation and support it. And, despite popular belief, a Blue Book value, in and of itself, isn't enough if you want your deduction to stick.

Making the valuation
The IRS says that the FMV of a vehicle in this situation is the price at which the auto would change hands between a willing buyer and a willing seller when:

• Neither party has any compulsion to buy or sell; and
  
  
• Both parties have a reasonable knowledge of relevant facts.

In fact, IRS Publication 561 has this to say on the subject:

Certain commercial firms and trade organizations publish guides, commonly called "blue books," containing complete dealer sale prices or dealer average prices for recent model years. The guides may be published monthly or seasonally, and for different regions of the country. These guides also provide estimates for adjusting for unusual equipment, unusual mileage, and physical condition. The prices are not "official" and these publications are not considered an appraisal of any specific donated property. But they do provide clues for making an appraisal and suggest relative prices for comparison with current sales and offerings in your area.

If you want your deduction to hold up under IRS review (read: audit), you'll have to make sure that you do the work necessary to prove that the FMV that you used on your tax return is the real FMV, and not some inflated value.

Making your deduction hold up
If a simple Blue Book valuation isn't good enough, what do you do? It's really not that difficult -- though it might be time-consuming. Here are the steps to take:

• Attach a detailed description of the vehicle.
  
  
• Take pictures and attach 'em: inside, outside, different angles, engine. Remember that a picture is worth a thousand words.
  
  
• Attach pages from your local "Auto Trader" or similar publication that advertises used cars for sale. Find vehicles that are similar to yours in looks and condition and factor those advertised sales prices into your FMV analysis.
  
  
• Get the Blue Book information and attach it. While it's not the only source, it's one that will help with other sources.
  
  
• How about a statement from your local mechanic or auto dealer? A simple statement claiming that the vehicle is in running condition with no known or apparent malfunctions would be a good thing to attach to the return. Heck, even if there are some problems with the vehicle, see if the mechanic will state the amount of money to fix the problem. You can then use that to factor into the correct FMV of the vehicle.

Remember to make copies of any documents that you attach to your tax return. Sometimes attachments get lost or separated from the tax return.

If you decide to donate your jalopy, remember that there is additional information that you'll be required to disclose on the tax return in order to correctly report the contribution. Use IRS Form 8283 and follow the instructions for these additional requirements.

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

September 27, 2002

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