Wealth Transfer 101: Charitable Giving with Appreciated Assets

Executive Summary

  • Making charitable gifts with appreciated assets (such as stocks or mutual funds) provides two substantial tax benefits — an immediate income tax charitable deduction and avoiding recognition of capital gain taxes on the sale of the asset.
  • Donor-advised funds and private foundations create the opportunity to match the timing of the charitable deduction with the highest income years, when the deduction is most valuable, while "pre-funding" planned charitable giving for many future years.

Clients engage in philanthropy for many reasons, including:

  • the opportunity to support causes about which they are passionate,
  • giving back to the community,
  • as a means of connecting with family and transmitting shared family values through generations, and
  • to obtain the prestige and social benefits that come with philanthropy.

Beyond the personal gratification of charitable giving, there are tax-related motivations that make it even more attractive. Charitable gifts create a valuable income tax deduction and reduce a client's estate for estate tax purposes; moreover, by giving appreciated assets (usually stock or mutual funds) instead of cash, clients can avoid the capital gains tax that otherwise would have been paid if the property was sold. Happily, after two years of strong gains in equity markets, clients' investment portfolios have large unrealized capital gains, creating a good opportunity to use appreciated securities for charitable gifts.

Of course, giving appreciated assets is not as convenient as simply giving cash or writing a check, and "checkbook giving" is the best approach for most small charitable gifts; however, for larger gifts (over $1,000), the benefit of using appreciated assets for gifts becomes more substantial.

Options for using appreciated assets

The most common ways to use appreciated assets for charitable giving include transferring appreciated assets directly to a charity or indirectly through a donor-advised fund (DAF) or a private foundation.

Direct gifts, in which a stock or mutual fund is transferred directly from a client's brokerage account to a charity's brokerage account, is simple, inexpensive and is often the best approach when the desire to immediately benefit the charity and the need for a large tax deduction coincide. But what about situations where these two facts don't coincide? In those cases, a charitable entity usually makes sense.

A donor-advised fund or private foundation are good alternatives for clients who want to receive a tax deduction in the current year but have not yet identified the charities they would like to support. Clients can give a large gift to the DAF or private foundation, claim an immediate tax deduction for the full amount of the gift, sell the securities and invest the proceeds tax-free in the entity, and then distribute gifts to charities over many years. This allows clients to match the timing of the charitable deduction with the highest income years, when the deduction is most valuable, and "pre-fund" their planned charitable giving for many future years.

While DAFs and private foundations are similar in some respects, there are important differences between them. DAF's are a flexible, cost-effective, low maintenance option for charitable giving. However, DAF's are sponsored by a public charity (e.g., a community foundation), and the sponsor is not legally obligated to follow gift requests (although they normally do). DAFs are ideal for someone who expects to make most of their gifts to other public charities but are less appropriate for more targeted giving, for example, if a client wants to sponsor a scholarship for specific children.

A private foundation is often a better approach for clients who want more control over their charitable donations and the foundation's investment portfolio, or who want to actively involve other family members in their philanthropy.

As an independent entity, though, a private foundation is more expensive and time-consuming to administer; consequently, we recommend that clients establish private foundations only when they expect to make gifts totaling $2-3 million or more and distribute them over many years (often multiple generations).

Figuring the tax deduction

The amount of the charitable gift income tax deduction depends upon the type of property being donated as well as the type of charity receiving the contribution. Gifts to public charities (including DAFs), as opposed to private foundations, are generally treated more favorably for income tax purposes.

The maximum deduction for cash gifts to public charities and donor-advised funds is 50% of the donor's adjusted gross income (AGI), versus 30% of AGI for cash gifts to private foundations. The maximum deduction for gifts of long-term capital gain property (e.g., stocks or mutual funds held for more than one year) to public charities is limited to 30% of AGI, versus 20% of AGI for gifts of appreciated assets to private foundations. Happily, the deduction for gifts exceeding these thresholds is not lost; rather, any unused deduction carries forward for five years following the year of the donation.

The deduction for gifts of short-term capital gain property is limited to cost basis, so one generally wouldn't use highly-appreciated short-term property for charitable gifts. Gifts of real estate, artwork and other non-publicly-traded assets to private foundations have special (and generally less favorable) deduction rules, with the deduction often being limited to the client's tax basis in the property.

These rules are summarized in the chart below.

Chart 1

By way of example, assume Jason Smith owns 100 shares of Google he purchased at $250 per share 3 years ago, and the current value is $500 per share. If Jason sells all 100 shares, he will pay $5,750 in capital gains tax ($25,000 x 23% combined state and federal rate). If Jason instead contributes the shares to charity, he will avoid paying $5,750 of capital gains tax and will receive a $50,000 charitable tax deduction, saving him $21,500 of tax ($50,000 x 43% combined state and federal rate). Thus, Jason can effectively contribute $50,000 to charity with a net cost of just $22,750.

Charitable giving with appreciated assets: A case study

It's not unusual for clients to have a combination of high employment income, highly-appreciated securities, and substantial charitable intent. This creates a situation where, with a little planning, clients can obtain very significant tax benefits.

Mary Smith is an executive at ABC Co., a large public company. She is 55 and expects to retire by year-end. For years she has actively supported a number of organizations, including her alma mater, her children's school, and several other charities, giving about $50,000 per year. She wants to continue to give at this level throughout her retirement. Post retirement, Mary plans to take some time off and then become involved in working with several of her favorite charities.

Mary has accumulated $2 million of ABC stock over the years, most of it before ABC went public, so her cost basis in the stock is just pennies per share. She also has substantial ABC stock option holdings, which will generate $5 million of income when she exercises them at retirement later this year.

The confluence of events — Mary's very high 2011 income, highly-appreciated ABC stock, and ongoing charitable intent — creates a great opportunity for strategic charitable giving. Mary establishes a donor-advised fund in 2011 and donates $1 million of ABC stock, where it is sold tax-free and diversified. In doing this, Mary has created a pool of charitable assets that will indefinitely fund her $50,000 of annual giving. By making the gift with appreciated ABC stock, she avoids paying over $200,000 of capital gain taxes. She also receives a $1 million tax deduction in 2011; her high income allows her to deduct all of it in 2011 (when her tax rate is at the highest level), saving over $400,000 of income taxes.

So, Mary has made a $1 million gift that "cost" her less than $400,000! While this exact fact pattern doesn't come along all that often, many Aspiriant clients can apply these principles and obtain a similar outcome.

No matter how or when you choose to make charitable gifts, funding your gifts with appreciated securities improves the cost effectiveness of your giving. Your team can help you determine how to best apply these principles to your own situation.

Kelly Cruz, JD
Manager - Strategic Planning

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