Publicly traded securities held for more than one year—stocks, bonds, exchange-traded funds (ETFs), and mutual funds—are the non-cash assets most frequently donated to charities. Why is this? It’s probably because these assets are widely owned by donors and easily transferred to charities.
What’s more, if you itemize deductions on your tax return instead of taking the standard deduction, donating these assets can unlock additional funds for charity in two ways. First, you potentially eliminate the capital gains tax you would incur if you sold the assets yourself and donated the proceeds, which may increase the amount available for charity by up to 20%. Second, you may claim a fair market value charitable deduction for the tax year in which the gift is made and may choose to pass on that savings in the form of more giving.
Case study: Gina Brantly
To illustrate the benefits of donating appreciated securities, consider Gina Brantly, who purchased 1,000 shares of publicly traded stock IBM five years ago at $5 per share. This gives her a cost basis of $5,000 in the stock.
IBM’s stock has risen in value to $50 per share, so her holdings’ total fair market value is $50,000. Gina plans to sell her entire position in IBM and donate the net cash proceeds to a donor-advised fund or other public charity. Assuming a 15% federal capital gains tax rate based on Gina’s income level, if Ginasold the stock, she would realize an appreciation of $45,000 and owe an estimated $6,750 in federal capital gains taxes ($45,000 x 15% = $6,750).
In this scenario, as shown in Option 1, after paying the federal capital gains taxes, Gina’s estimated net cash available for charitable giving is $43,250.
Now let’s review Gina’s benefits from gifting her stock directly to a donor-advised fund or other public charity, as shown in Option 2. In this scenario, Gina may be able to eliminate capital gains taxes ($6,750) while potentially claiming a current year income tax deduction for the fair market value of her stock ($50,000), assuming she itemizes her deductions.
Additional considerations
In addition to the potential tax benefits described above.
1. Donate before selling.
To maximize the potential tax benefits described above, you should transfer your appreciated securities, held for more than one year, directly to a donor-advised fund or other public charity and should not sell the securities first.
2. Avoid prearranged sales.
You should not enter into any arrangement that would legally compel a donor-advised fund or other public charity to dispose of the securities upon receipt. This kind of “prearranged sale” could reduce or eliminate the tax benefits of making your donation. Upon receiving the securities, the donor-advised fund or other public charity controls the asset. For most public charities, the general policy is to sell contributed securities promptly, but a charity may reserve the right to sell at any time.
3. Restricted stock rules may apply.
Executives with concentrated and restricted positions in a public company stock may be able to donate shares to help reduce tax exposure in their portfolios.
There are unique considerations for gifts of restricted stock that you will want to consider. For example, suppose your stock is restricted by legend or is “control” stock owned by an affiliate of the issuer (i.e., you are an officer, director, or 10% shareholder). In that case, your company’s general counsel must permit you to transfer the stock to charity. As a general rule, the restricted stock must be sold following Rule 144 resale restrictions.
Contributions of long-term held restricted stock to a public charity, including a donor-advised fund, may be deductible at fair market value as of the contribution date. A qualified appraisal may be required to substantiate the fair market value. Still, valuation discounts may apply if restrictions are not lifted before gifting.
4. Master Limited Partnerships have unique rules.
Master Limited Partnerships (MLPs) are a significant exception to the typical fair market value deduction for publicly traded securities held for more than one year. Suppose you have an investment in a MLP and itemize deductions. In that case, a qualified appraisal may be required to substantiate the fair market value, and your charitable deduction must be reduced by the amount of ordinary income that would have been realized if the asset had been sold at fair market value on the date contributed. MLPs with substantial accumulated depreciation can significantly reduce the charitable deduction. In addition, if the partnership carries debt (as is often the case with MLPs), you may be liable for taxes.
5. Annual limits apply to charitable deductions.
Overall deductions for donations to donor-advised funds are generally limited to 50% of your adjusted gross income (AGI). The limit increases to 60% of AGI for cash gifts, while the limit on donating appreciated non-cash assets held more than one year is 30% of AGI. The IRS permits a carryover for five tax years, should your charitable deduction exceed AGI limits in a given tax year.
Please be aware that gifts of appreciated non-cash assets can involve detailed tax analysis and advanced planning. This article is only intended to be a general overview of some donation considerations and is not intended to provide tax or legal guidance. In addition, all gifts to donor-advised funds are irrevocable. Please consult with your tax or legal advisor.