Many people are interested in donating to causes that matter to them right now. If you are donating a significant amount to a charity you may want to consider donating appreciated stock, mutual funds, or ETFs instead of cash.
Why gift away your capital gain?
Unlike you, charities can sell your appreciated investment and not pay any capital gains taxes. This means you can donate an investment that has increased in price (appreciated in value) to your charity and avoid paying capital gains taxes on the sale of that investment in the future. Then, you can use the cash you would have donated to your favorite charity to rebalance your investment portfolio.
If you’re wondering what a capital gain is, you’re not alone.
A capital gain is the difference between what you paid for an investment and what you sell it for. As an example, let’s say you purchased 100 shares of ABC stock for $10 a share. That means you spent $1,000 buying 100 shares. This $1,000 becomes known as your cost basis.
Let’s pretend you hold the ABC stock for 5 years and the value of the stock doubles. Now your $1,000 investment is worth $2,000. The difference between your basis (what you paid for the stock, or $1,000 in our example) and what the stock is now worth ($2,000) is your capital gain.
Capital gains can be short term (which means you held the investment for less than a year) or long-term (you held the investment for more than one year). This matters for taxes, which we’ll cover in a second.
If you are donating appreciated investments you must have owned the investment for more than one year and you must have a long-term capital gain to get the benefit of deducting the full amount. If you have owned the investment for less than one year you will only be able to take a charitable deduction on your basis.
Even if you end up purchasing the exact same investment with the cash you replace your donated investment with, you are increasing your cost basis in that investment. Which may reduce the taxes you pay down the road if the investment increases in value and you sell it.
Taxation of Short-term capital gains vs. Long-term capital gains
Short-term capital gains are taxed at your highest income bracket (10%, 12%, 22% 24%, 32%, 35%, 37%), which for most of my clients is relatively expensive. Long-term capital gains on investment assets are taxed at more preferable long-term capital gains rates of 0%, 15% or 20% depending on your tax bracket. Collectibles are taxed differently so talk to your CPA or tax advisor before you sell coins or art.
You can technically get hit with the 3.8% Medicare surtax, creating a fourth capital gains tax bracket but let’s keep it simple.
Why You Should Gift Away Your Capital Gain: Back To Our Example
Before you write that check call your Certified Financial Planner TM located in Richmond, VA.
Remember, you paid $1,000 for the stock (your cost basis) 5 years ago, now the stock is worth $2,000 which means you have a long-term capital gain of $1,000. For simplicity, let’s focus on a 15% Federal long-term capital gains bracket. If you were to sell that stock for any reason, you would have to pay 15% in long-term capital gains taxes and state capital gains taxes (depending on your state).
15% x $1,000 = $150 in taxes
Let’s say you want to give $2,000 to your favorite charity. Instead of taking giving $2,000 in cash you decide to donate that stock and replace the stock you donated with the cash you were planning to donate.
Now you can effectively give away your capital gain tax liability and still benefit the charity.
Remember, the charity does not pay capital gains taxes. Which means they benefit from the full $2,000. Whereas if you were to sell it you would effectively receive $1,850 at a 15% Federal long-term capital gains bracket.
This might seem like small potatoes on a $2,000 investment.
You may be right, but this kind of tax-savvy planning can really add up over a lifetime.
If you increase the dollar amount to a $10,000 long-term capital gain you’re looking at possibly $1,500 in taxes or more on the sale of the investment. How much more?
If you’re a Virginia resident in the highest income tax and capital gains tax bracket, you would pay the 20% Federal Long-term capital gains tax rate, the 3.8% Medicare Surcharge, and 5.75% Virginia long-term capital gains tax rate. This means your effective tax rate would be 29.55%!
Replacing Your Gift With Cash
The key here is to track your gift and then replace the donated asset with cash inside your portfolio. Use the cash to buy a new investment or replace the investment you just gave away.
This is particularly powerful if you have a concentrated stock position with a large capital gain in it. You can support your charity, reduce your capital gain tax liability, and diversify your portfolio. Win-win-win.
Should you consider this if the stock market is down?
Yes, even in a down market, this strategy can still work as long as you have a long-term capital gain in the investment asset and cash to replace the donation inside your portfolio.
Donating Appreciated Investments To Charity If You Don’t Itemize
After the Tax Cut and Jobs Act of 2017 very few Americans itemize on their federal income taxes. Donating appreciated investments can still allow you to pick up a tax benefit even if you don’t itemize.
Why? You’re still giving away the long-term capital gains tax and effectively increasing your cost basis by replacing the investment you gave away with cash. You are reducing the future taxes you would otherwise have to pay when you go to sell your investments to fund your living expenses later in life.
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Questions for Lauren?
Financial planner and advisor, Lauren Zangardi Haynes, CIMA®, CFP®, CEPA works with business owners and leaders in Richmond and Williamsburg, VA. She also works virtually with clients nationwide.
As a fiduciary, she offers comprehensive Fee-Only financial planning and investment advisory services so you can live your dreams with confidence.