With less than a month to go before the end of the year, there’s no time like the present for some last minute tax planning.
One major tax break that many of us take advantage of relates to charitable donations. And if you’re anything like us, you leave your charitable giving until the very last minute.
From a tax perspective, charitable donations are a great deal. Assuming you itemize, you can deduct the value of your contributions, and reduce your taxable income, thereby saving you money in direct proportion to your marginal tax rate.
But did you know that you can donate appreciated assets (e.g., stocks, mutual funds, or other investments), claim a deduction for their fair market value, and completely wipe away the associated capital gains liability in the process?
Sounds too good to be true, right? Well, it’s not.
Donating capital gain property
One big issue is how long you’ve held the assets in question. If you’ve held them for less than 12 months, then they’re technically considered to be short-term capital gain property and you can only deduct what you paid for them.
But if you’ve held them for more than 12 months, then they’re considered long-term capital gain property and can deduct their fair market value as of the date of your donation without paying taxes on the (still unrealized) gain.
Limits on deductibility
As you might expect, there are also limits on how much of your charitable giving is tax deductible. These limits are quite high, so they won’t impact most of you, but they’re still worth mentioning…
You can donate as much as you want but, for most charities, you can’t deduct amounts in excess of 50% of your adjusted gross income (AGI). For donations of capital gain property, this limit shrinks to 30%.
As for the charity, they won’t have to pay capital gains taxes either, so this is a classic win-win. You get a tax deduction plus you dodge the capital gains taxes and the charity gets your support. The only loser here is the IRS, but… Oh well.
Using a donor-advised fund
Perhaps the biggest challenge is that not all charities are set up to accept capital gain property. And even if they are, there can be some additional hoops to jump through. The good news is that there’s a workaround…
Instead of dealing with charities on a one-on-one basis, you can funnel your donations through a donor-advised fund such as those offered by the Vanguard Charitable Endowment Program or Fidelity Charitable.
Donor-advised funds are essentially “umbrella” charities that are specifically set up by investment companies. You make donations into a dedicated account, advise the company on how to invest the funds, and then direct them to disburse funds to qualified charities of your choice.
Bunching deductions; resetting your cost basis
The major advantage of donor-advised funds is that they make it dead easy to donate appreciated assets. They also enable you to aggregate your charitable giving into a single tax year (in case it turns out to be advantageous to “bunch” your deductions) even if you’d prefer to spread out your donations over time.
And even if you don’t want to get rid of the asset in question, this strategy can be used to effectively reset your cost basis to a higher level. All you have to do is donate appreciated shares instead of cash and then use the cash you would’ve donated to immediately buying replacement shares.
As with tax gain harvesting, the wash sale rule doesn’t come into play here. Thus, if you’re planning on making a donation anyway, the donation of appreciated assets instead of cash can provide an additional tax benefit.
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