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The do's and don't's of tax deductions: Donating your car

Consumer Reports News: February 28, 2011 09:08 AM

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Find the Deduction is a game with constantly shifting rules. Each year Congress changes something in the tax law, the Internal Revenue Service issues opinions, and tax courts make their rulings. If you like a challenge, learning this year's deduction options is like a game of chess. If not, it's a tedious round of hide-and-seek. But either way, it's worth knowing the rules.

In Part 4 of this multi-part series, we look at charitable donations of automobiles, which are detailed in IRS Publication 4303, "A Donor's Guide to Vehicle Donations."

Donating your clunker to snag a tax deduction seems easy. A parade of charities and third-party companies advertise that they'll pick up your old car, hassle-free, in return for potential savings on your Form 1040. But the IRS has tightened the rules on these deductions, largely because of abuses. To reap the maximum benefit, you'll need to understand both the tax rules and the car-donation business. Otherwise, that well-intended act of largesse could come back to run you over.

If your goal is to make money, donating for a deduction may not be the way to go. The deduction is worth only a fraction of the car's value. If your marginal tax rate is 28 percent, a donated car worth $2,000 will generate a deduction of only $560. You could get more by selling the car yourself.

Federal law also limits taxpayers in setting the value of car donations. If the charity keeps the car and uses it for, say, delivering meals or carting around children, you can claim the fair-market value, determined by a service such as Consumer Reports Used Car Price Report or Kelley Blue Book. But if the charity arranges to have the car sold at auction, as most do, you can deduct only the amount that the charity gets for it. So if you donate a vehicle with a fair-market value of $2,000 and it's sold for $1,500 at auction, you will get a deduction of just $420, assuming you're in the 28 percent tax bracket.

Still, a lot of folks love the convenience and altruism of a car donation. To ensure that your contribution will be handled properly--and also remain eligible for a deduction--check up on the charity first.

• Find out if the charity is an IRS-approved 501(c)(3) organization. If not, your deduction could be disqualified. Approved charities are generally listed in IRS Publication 78 at Your church, synagogue, mosque, or temple might not be listed but still qualify.

• See how much of your donation will go to the charity. A 2003 survey by the Government Accountability Office found that charities often got as little as 5 percent of a donated car's claimed value after processing and fundraising costs. So ask the charity's development office what percentage of the sale price the charity will get.

• Consult the Better Business Bureau's National Charity Report Index, which rates charities on 20 accountability standards. Another nonprofit watchdog is Charity Navigator. It reports what share of a group's donations actually go to good works.

Cover your back bumper

To back up your deduction, make sure you have the name and address of the charity, the date of the donation, the place where you donated the car, a description of the car, and a written acknowledgement from the charity. Keep a copy of the title transfer. Report the transfer to your state motor vehicle department, and cancel your car insurance. Remove license plates--unless state law says otherwise--as well as registration and inspection stickers. As the box below notes, you don't want the next owner's problems tailing you.

This article was also published in Consumer Reports Money Adviser.

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