Q:

Subject: Charity

Kerry- I have a problem lots of people would love to have. A couple months ago I spent 100 dollars on a raffle ticket to win a Harley Davidson V-rod at a charity auction and we won. Apparently we will receive a 1099 form and have to pay tax on $17,500 which according to the charity is the value of the Harley. The problem is that the Harley is actually a 2004 model and although the list price in 2004 may have been $17,500 the bike is not worth anywhere near that. You can buy a 2006 bike new for less than $17,000. I do not want to keep the bike and have had it advertised for sale. I figure it is worth about $12,000 and the best offer I have received is for $10,000. In my opinion, I am going to have to pay tax on income I never received. Any thoughts? Thanks for all of your help and your great site.

A:

Congratulations on your win. I've been tempted myself to enter some of those kinds of contests that I've come across; but I'm always too practical when considering the steep odds against winning.

You have a very valid point with the discrepancy between the claimed value and the actual value. Believe it or not, I have actually had a number of clients over the past several years with the exact same problem. They had won cars, boats and other big ticket items and the values reported to IRS were the full retail sticker prices, even though everyone knows that nobody pays full price in an actual purchase transaction. The charities or sponsors of the contest won't correct the 1099s to the more realistic value because they want the PR from the highest values possible.

As far as I can recall in those other cases, the items were from the current model year; and we still had to deal with this issue. In your case, receiving a Harley that is already two years old, the discrepancy is more extreme.

The following ways to handle this situation are all based on my real world experience with clients. All of them were accepted by IRS with no problem.

The easiest case will be if you do sell the Harley in the same year as you receive it and have the prize income reported. In that case, you would show the full $17,500 amount of the prize income on the "Other Income" line of your 1040. That plus any sales tax you have had to pay to register the bike will be your cost basis of the Harley.

You would then show the sale of the bike on either Schedule D or Form 4797 to reflect the net loss compared to your cost basis. You can also add in the selling expenses you incur, such as ads you pay for.

If you decide to keep the bike, or can't sell it until a later year, you will want to adjust the net value down for the bike's actual market value. The way I have done this is to show the full 1099 amount ($17,500) on the line for "Other Income." Then in the Adjustments to Income section on the front of the 1040, I would enter "Adjustment Of Prize To Actual Value Per Professional Opinion" and enter the difference between the $17,500 price and what it would actually sell for. You should also attach statements from your experts (Harley dealers) as to their professional opinion of what the bike was worth at the time you received it.

As I've said countless times, the ability to attach additional explanatory info such as that is the main reason I have always been opposed to electronic filing of tax returns.

Another thing to keep in mind is that with a large amount of gambling income being reported on your 1040 for this year, it allows you to deduct gambling losses up to the amount you show as winnings. What most people miss in situations like this is the fact that the losses can be from all kinds of gambling; not just the kind where you won. Lotteries, casinos, race-tracks, office pools, raffles, etc. all count. You do need to prepare good records of your losses and you can only count what you lost during the same calendar year as the winnings. I've long noted that it is much better to win big early in the year so that you know to keep track of your losses for that year than to win on New Year's Eve and have to go crazy trying to reconstruct your losses for the previous 364 days.

As always, these comments are not intended to substitute for the services of a qualified and competent professional tax advisor who can more closely work with you and your unique circumstances to handle everything in the most advantageous manner.

I hope this helps.

Kerry Kerstetter

Follow-Up:

Dear Kerry-
I had a feeling that you would not let your clients get stuck paying taxes on imaginary income. Good for you.

The charity sent the dealer a check for 12K which is what the bike is worth. I imagine the dealer is claiming a charitable write off for 5.5K (17.5K - 12K). The charity sold 300 tickets for 100 dollars a piece. On an after tax basis if I have to pay tax (45%) on the entire 17.5K and only sell the bike for 10k I would only end up winning about $2200. 1/300 chance to make 22 times on your "investment" is pretty lousy odds. I am not much of a gambler--buying and selling stocks for a living is enough excitement for me.

I am very impressed with you site and you ability to educate and help others. I am sure that staying on top of the tax code and dealing with clients is a full time job. Keep up the good work and thanks very much for the reply.

My Reply:

If you can get written documentation of the $12,000 payment for the bike, such as a letter from the charity or the dealer, that would be perfect to attach to your 1040 in the case that you don't sell the bike this year.

If you do sell it this year, you can just go ahead and show the loss on Schedule D or Form 4797, depending on the advice of your personal tax consultant and the extent of your other capital gains.

Although it has absolutely no effect on your personal taxes, your assumption that the dealer will be able to claim a tax deduction for the $5,500 difference in values is wrong. The dealer will simply show it as a sale for $12,000 and deduct his actual cost of the bike as a normal Cost of Goods Sold. There is no actual charitable deduction for selling inventory items to charities at a discount.

Good luck with selling the bike before the end of the year.

Kerry Kerstetter

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 11/16/2005 08:59:00 PM Send this post: