Donating Stock to Charity
When donating to a charity, gifting appreciated stock is usually better than giving cash. A stock donation can allow you to give more, because it is exempt from capital gains tax. Additionally, it provides the potential for greater income tax deductions.
Advantages of Donating Stock to Charity
When it comes to charitable giving in the form of donations, most people automatically think about gifting cash. However, this isn’t your only option, and it’s often a suboptimal choice.
Other assets, such as automobiles, real estate and financial securities (stocks, bonds and hybrid instruments), can also be donated. From a financial standpoint, the latter category is oftentimes the best asset to donate.
Explore a few of the advantages of donating common stock, rather than cash.
Donate a Greater Amount and Increase Your Tax Deduction
While volatile over the short-term, stocks are long-term growth assets, which have the potential to appreciate considerably over time. This is great for accumulating wealth, but it can be problematic from a tax perspective.
This is because the sale of an appreciated stock triggers a federal capital gains tax. For long-term holdings, those owned longer than a year, the maximum capital gains tax rate is 20 percent. For short-term holdings, the rate is even higher.
While the tax drag associated with a stock sale can be significant, it offers the following unique opportunities to charitable donors:
- When you donate stock to an IRS-qualified charity, you can avoid paying the capital gains tax.
- If you itemize, you have the potential to deduct the full fair market value of the gift from your income taxes, up to IRS-permitted limits.
Example: Stock vs. Cash Donation
Let’s take a look at how this works. Assume the following:
- Mary wishes to donate to her favorite IRS-qualified 501(c)(3) charitable organization.
- She has identified $100,000 of Company XYZ stock she bought years ago for the donation. It has a cost basis of $60,000.
- She can either (1) donate the stock or (2) sell it first and donate the proceeds.
- Mary faces an effective income tax rate of 30 percent and a capital gains tax rate of 20 percent. Additionally, she itemizes her taxes and faces no deduction limit on this donation, given her current income level.
As illustrated below, if she donates the stock directly to the charity (Option 1), rather than selling it first and making a cash donation (Option 2), she can greatly enhance the value of her donation.
If she makes a direct stock donation, the charity will receive $100,000 of value versus only $80,000 via the cash donation. Beyond that, Mary will capture an income tax deduction of $30,000 with the stock donation versus only $24,000 via the cash route. In aggregate, the personal finance decision offers $26,000 of incremental value ($130,000 – $104,000 = $26,000).
In addition to the tax-related benefits outlined above, donating stock to charity can be an efficient way to reduce highly concentrated stock positions and facilitate the rebalancing of your portfolio.
While fulfilling its intended philanthropic purpose, the donation can simultaneously right size individual stock positions and pull your total stock exposure back toward its target allocation.
The process can be streamlined by taking advantage of an investment vehicle known as a donor-advised fund. Essentially, this is a charitable investment account that optimizes the way you give to charities.
Instead of making one-off donations to multiple charities, you only make donations to the donor-advised fund, which has the resources and expertise to efficiently execute downstream contributions in accordance with your instructions, while addressing the associated compliance work.
The process can greatly alleviate your administrative burden, which includes tax filings.
Additionally, a donor-advised fund provides you flexibility when you’re not sure which charities should receive your stock or when you want the grants to occur.
You can simply make a bulk donation to the fund, take a tax deduction for the current year and support your favorite charities over time.
Important Tax Considerations for Filers with Itemized Deductions
As discussed previously, if your stock has increased in value since purchase, donating it directly is normally the ideal charitable strategy.
However, if it has lost value, it is generally better to sell it first and then donate the proceeds. This way, you can use the capital loss to improve your tax position.
If you decide to donate stock, be aware of the IRS-imposed limits on deductions.
First, know that donating stock offers a greater tax advantage for long-term holdings than short-term holdings. If you donate a long-term stock to charity, you can deduct its fair market value up to IRS-stipulated income limits.
However, the deduction for a short-term stock is limited to the lower of the stock’s cost basis or current fair market value.
Beyond the guidance above, aggregate limits for gifted stock, whether donated directly or via a donor-advised fund, are as follows:
- If the donated stock is in a long-term capital gain position, the deduction is limited to 30 percent of adjusted gross income. Excess amounts can be carried forward for five years.
- If the donated stock is in a short-term capital gain position, the deduction is limited to 50 percent of adjusted gross income. Excess amounts can be carried forward for five years.
You can also donate stock to a private foundation. However, the deduction limits are much more restrictive.
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- Internal Revenue Service. (2021, August 18). Charitable Contribution Deductions. Retrieved from https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions
- FINRA. (n.d.). Rebalancing Your Portfolio. Retrieved from https://www.finra.org/investors/learn-to-invest/key-investing-concepts/rebalancing-your-portfolio
- J.P.Morgan. (2021, April 5). The impact of holding a concentrated stock position. Retrieved from https://www.jpmorgan.com/wealth-management/wealth-partners/insights/the-impact-of-holding-a-concentrated-stock-position
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