Contributing to your favorite charity is often simple: you write a check and pass it on. As a result, you receive an income tax deduction and the charity has the donation to help with its cause. While a popular route, this isn’t necessarily the best if you want to help your clients save on their tax bill – and who doesn’t?
You can educate your clients on how to make a significant contribution to a not-for-profit organization and have less tax to pay to the IRS by showing them other contribution strategies. One, in particular, that might be a significant benefit your client and the charity has to do with appreciated assets that have been owned for more than 12 months.
Selling an Appreciated Property
There are many different assets whose profits would be taxed as a long-term gain when sold after 12 months. These assets include shares of individual stocks, mutual funds, exchange-traded funds, bonds and real estate. However, if your clients adopt the policy of providing appreciated assets to charities, then they can deduct the full market value from their federal and state taxes.
If they sell a property before donating the proceeds to the charity, then the IRS will collect a sizeable percentage of the profits. Therefore, the taxpayer has a higher tax bill and the charity receives less.
Not Just for the Super Rich
Everyone likes to give to charity, especially those on more modest incomes. Even though donating appreciated property to charities and saving on taxes might seem unfeasible to those on smaller incomes, this is not true.
Anyone who owns appreciated property for more than 12 months can save on taxes by donating it directly to charity, rather than selling it and then donating the cash proceeds. The charity will be happier because it does not incur taxes when they sell appreciated property.
In addition, clients could save significant tax. Imagine they bought stock in a company for $5,000, and now the stock is worth $10,000. When they sold those stocks, assuming they fell into the short-term capital gains bracket of about 30 percent Federal and state tax, their tax liability on the sale would be $3,000.
However, by donating to charity, they can avoid these tax bills. They basically donate the stock as stock, not as cash. The charity probably goes on to sell it, but the taxpayer gets to deduct a donation of $10,000. This means they were able to avoid paying the capital gains, while receiving full benefit of the stock value.
They could buy back the stock at the current market value. Repurchasing of the stock allows them to measure the gain or loss on another sale against a new, higher cost basis of $10,000, not the original $5,000 paid. This is a tactic that is also sanctioned by the IRS.
Considerations for Appreciated Assets Donations
Of course, other concerns and complications don’t make this process easy. If your clients want to explore this option, they have to consider the following and speak to a financial professional like you to follow through.
One concern is that they cannot claim this tax break if they hold shares in IRAs or another tax-deferred retirement plan. The IRS also looks unfavorably on donations where assets have been owned for less than a year.
In addition, unlike simply writing a check to charity, the paperwork necessary to transfer ownership of any appreciated property to the not-for-profit organization can take a while. The completion of the gift, which is often dependent on the charity receiving the paperwork, has to be completed by Dec. 31, if it is to be contributed to that tax year. There are stricter regulations that must be applied if the paperwork needs to be seen by a banker, broker or issuing corporation. In these circumstances, the date of stock transference isn’t until it has been recorded on the corporation’s books.
Joseph Alioto, a lawyer and former mayor of San Francisco, fell afoul of this trap. The tax court held that his donation wasn’t completed prior to Dec. 31 of the tax year in question – even though the deeds were executed in December – because they weren’t recorded until well beyond the close of the year.
Also, make sure your clients are valuing their stocks correctly. IRS guidelines tell us to use the average of the stock’s high and low prices on the day of delivery when donating shares of publicly traded companies. If they are using mutual fund shares, they must use the closing price on the date of delivery. Privately traded stock must be valued on what you received from the third party.
Finally, they should also look at whether there is any value in donating and not selling. If they have appreciated property that has lost value over the course of the ownership, then it might be best to sell the property and donate the cash proceeds. This would allow them to deduct the contributions, while also claiming capital losses to reduce (or erase) the tax on capital gains/ordinary income.
Demonstrate your value to your clients and discuss appreciated asset donations!
Interested in more information on the topic of giving to charity? Check out this article on “5 Tax Tips for Charitable Contributions.”