What Is a Fractional Gift?

A fractional gift entails a gradual charitable donation of a work of art in order to receive the maximum tax break. In the United States, where fractional giving was used by many wealthy individuals in the 2000s, the practice was essentially ended when the passage of the Pension Protection Act of 2006 negated many of the advantages. A fractional gift allows donors to realize a substantial tax break over a number of years while still retaining possession of a work of art.

The fractional gift structure allows for the possibility of the tax break increasing in value as the value of a donated work of art appreciates. The key to this calculation was the fact that the capital gains tax rate on appreciated artwork is higher than the rate for other assets. Other than the benefit to wealthy individuals and art collectors in the form of a tax break and the ability to retain their artwork, museums benefited from a significant influx of donated works of art.

Key Takeaways

  • A fractional gift refers to the donation of a work of art in order for the owners to receive the maximum tax break.
  • As a work of art appreciates in value, the fractional gift structure allows the owners to get a tax break while still retaining their ownership over the art.
  • This is because the capital gains tax rate on appreciate artwork is comparatively higher than on other assets.
  • Museums benefited from a large influx of donated works of art due to fractional giving. For example, a 10% fractional gift of artwork allows a museum to display it for 10% of the year (36 days), giving the donor a 10% deduction of the item's appraised value that year.
  • The practice was essentially ended by the passage of the Pension Protection Act of 2006.

How Fractional Gifts Work

A number of factors contributed to the popularity of fractional giving in the United States in the 2000s. They included a surge in prices for works of fine art, and a 28% tax rate on capital gains if such works of art were sold at a profit, while the prevailing tax rate on the sale of other capital assets, such as stocks and real estate, stood at just 20% (temporarily lowered to 15% in 2003).

Each factor led wealthy individuals to donate a large number of works of art to achieve a charitable income tax deduction. Since some works of art were immensely valuable and historically significant, some donors chose to make fractional gifts of some works in order to stretch their deductible charitable donation over many years while the value of the donated work continued to rise in value.

Example of a Fractional Gift

A 10% fractional gift of artwork allows (but does not require) a museum to display it for up to 36 days per year. The donor is then permitted to take a deduction worth 10% of the item's appraised value that year. With each year, the museum is permitted to display the work of art for proportionally longer periods, though in reality, the artwork might never leave the donor's home due to the cost, logistical burden, and danger of moving valuable and sometimes fragile works of art. 

Fractional Gift Loophole Closed

Section 1218 of the Pension Protection Act made several changes that addressed what many considered a tax loophole. For example, it required that any gift be completed the earlier of ten years from the first donation or the donor's death, otherwise, any charitable deductions would be recaptured along with a 10% penalty.

The rule also required the donee to take possession of the donated item and would freeze the value of any charitable deduction at the time it was first donated. Previously, the donor was allowed to deduct the fair market value of each donation.