What started as an innocent blog post is now a fully published article. My friend Professor Brendan Cunningham and I have published an article in the latest issue of Tax Notes Federal entitled “Tax Developments in Charity Auctions.” You’ll have to head to Tax Notes to read the full article (with some great graphs courtesy of Prof. Cunningham). But, I’ll provide some excerpts below:

Charity auctions have come a long way from the days when local businesses donated a free meal or service and a few hundred or thousand dollars were raised for an important cause. For example, in the fall of 2019 the eighth “Only Watch” auction was held in Geneva, Switzerland. Some of the most elite watch brands in the world create one-off versions of their watches for this auction, and the proceeds benefit medical research for the treatment and prevention of Duchenne Muscular Dystrophy. In two and a half hours almost $40 million was raised, and the auction included the sale of the most expensive watch in the world ($31 million). Similarly, in 2019 Christie’s auction house participated in more than 400 charity auctions worldwide and raised a total of $65 million.

As I wrote in my initial blog post, according to the IRS, donors (i.e., auction bidders) who purchase items at a charity auction can claim a charitable deduction for the excess of the purchase price on an item over its fair market value. All the donor has to do is show that he or she knew the value of the item was less than the amount paid. For example, if an auction house publishes an estimate in a catalog, that estimate can serve as a good estimate an item available for bidding. Assuming the donor has no reason to doubt the estimate, the donors can then point to auction estimates as their basis come tax season.

We continue the article by analyzing the economic incentives that result from this IRS rule. How does this impact the bidding of a rational bidder, and what mistakes might result from misunderstanding these rules? How does it impact the auction houses selling these lots, as well as their seller clients?

I initially became interested in this question when looking at Jack Nicklaus’ Rolex Day-Date, which Phillips sold at its Game Changers auction in December 2019. Per the Phillips catalog, 100% of the proceeds from Jack Nicklaus’ watch benefitted the Nicklaus Children’s Health Care Foundation. But, the impact of charity auctions reach far and wide, and our article explores these ideas further.

We conclude by writing:

Auctions are a novel and dynamic way to encourage philanthropy. For charitable giving to continue to thrive in the auction ecosystem, it is increasingly important for bidders to understand the tax implications of their participation. Otherwise, surprises and disappointments can dissuade participants. In addition to the issues we have raised here, other considerations will undoubtedly emerge as charity auctions continue to evolve.

Read the full article Tax Developments in Charity Auctions here.