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 do have an old auto or boat that you can't quite figure out what to do with. Then you hear that ad on the radio or see a notice in the newspaper that tells you about saving tax dollars by donating the vehicle to some worthy charitable organization. You decide to do it. But is that the right decision for you? Let's take a look.

Itemized deductions
A donation of this type is just another form of a charitable contribution. As such, it's another component of your itemized deductions. If you normally itemize your deductions (including medical, interest, taxes, charity, and miscellaneous items), then the charitable contribution 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 ($9,500 for married folks, $4,750 for singles, and $7,000 for head of household status for 2003 and indexed for inflation annually). 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 limitation amounts, that contribution won't reduce your taxes.

A percentage game
If you're in the 25% federal tax bracket, it means that you'll get tax relief of $25 for each $100 of contributions. So if you donate a vehicle that has a fair market value of $4,000, you could save an additional $1,000 in taxes.

Which begs the question: Why in the world would you not just sell the vehicle for $4,000 and put that money in your pocket (tax-free)?

There are several valid reasons. You might really care about the charity to which you are making the contribution. Perhaps you are busy and don't want the hassle of trying to sell the car. You might not want to dicker with an auto dealer about the value of your car as you shop for a replacement vehicle. The darn thing might just not be running, and you simply want the charity's tow truck to take it down the road.

Or... you may be inflating the value of the vehicle in order to stick it to Uncle Sam, and get your money out of the vehicle with no hassle.

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. It's quite possible that your car is a piece of junk. It's not running because the engine has been torn apart. The paint is worn. The interior is ripped and shredded. You've already talked to a couple of people and they said they wouldn't pay $500 for your jalopy.

But you should still be OK, since you went on the Internet and found that the value of a similar vehicle was actually $4,000, right? Wrong! The IRS is aware of this ploy, and has (and will continue to) audit many of these tax returns (i.e., donation of auto). The IRS is well aware that most folks would be better off selling the vehicle and taking the tax-free cash. So the IRS is curious as to how the FMV of the vehicle was determined.

Certainly the charity picking up the vehicle will provide a value, right? Wrong again. It's not their job or obligation to provide the valuation of the vehicle. That's your job. And it's your job to obtain as much information as possible to support your valuation. A simple "blue book" value alone isn't nearly 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.

So if you want your deduction to hold up under IRS review (read: audit), you'll have to prove that the FMV 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, but it might be time consuming. Here are some steps you can take to make sure that your valuation holds up should the IRS want to take a peek:

  • Attach a reasonably detailed description of the vehicle.

  • Take pictures of the car, inside and out -- even the engine. Remember that a picture is worth a thousand words. Attach the photos to your return.

  • 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 to prove valuation, it's one that will help with other sources.

  • How about a testimonial 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 factor that into the correct FMV of the vehicle.

Make copies of any documents that you affix to your tax return. Sometimes attachments get lost or separated.

Finally, if you do decide to donate your car, 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.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.