How Appreciated Assets Earn Tax Breaks

Businessmen signing paperwork
Robert Daly

When my clients make donations to their favorite philanthropies, most of them reflexively write checks as it’s the easiest way to qualify their gifts for charitable deductions.

But before they reach for their checkbooks, donors who want to make major gifts—and also lose less to the IRS—will do themselves a favor if they first familiarize themselves with other often-overlooked ways to contribute.

For instance, the charitably inclined realize significant tax benefits when they donate appreciated properties owned for more than 12 months that would otherwise be taxed as long-term capital gains when sold. Some common examples are shares of individual stocks, mutual funds and exchange-traded funds.

The “give ’em away” gambit permits contributors of appreciated assets to deduct their full market value when donated. Savvy benefactors also avoid all of the federal and state taxes assessed on profits realized from the sale of these investments, effectively decreasing the cost of donations.

Example

Alex Vennebush decides to fulfill pledges aggregating $20,000 to several schools. Astute Alex also wants to diversify his investment portfolio. He decides to sell $20,000 in shares of Lady Godiva Accessories (LGA), one of his big winners which has skyrocketed in value since he paid $2,000 for the shares a number of years ago.

How will this all play out when Form 1040 time rolls around?

For the 2018 tax year, he expects to be in a combined federal and state bracket of 35%. Although sending checks totaling $20,000 will trim his taxes by $7,000, he’ll be liable for taxes of $2,700 (15% of the $18,000 profit) on the gain from the LGA sale. Investor Alex’s long-term capital gains rate is 15%, not counting applicable state income taxes. The rate goes as high as 23.8% for those who are in the top ordinary income-tax bracket of 37% and subject to the 3.8% Medicare surtax on investment income.

As a less taxing alternative, Alex could donate the LGA shares to the schools. They’re all tax-exempt entities that incur no taxes when they sell the shares and so end up with close to the same amount of money. Not only does Alex garner the same $20,000 write-off and $7,000 tax reduction, but he also avoids the $2,700 capital gains tax levy. His total savings of $9,700 effectively decreases his $20,000 contribution’s cost to $10,300.

Keep two key caveats in mind:

  1. 1. There’s no additional tax break if Alex donates shares owned less than 12 months. The IRS restricts his write-offs to what he paid for the shares or their current value, whichever is less.

  2. 2. Alex shouldn’t donate depreciated shares or other investments. Instead, he should sell the shares and then donate the sales proceeds to charities. That will allow him to claim both the donation deduction and the capital loss.

What should Alex do if he’s unsure whether to relinquish his position in LGA?

He should still donate the shares, while using the $20,000 in cash that he would’ve otherwise donated to repurchase the shares. That way, he preserves the $20,000 deductions and dodges $2,700 of capital gains taxes on the $18,000 gain. Moreover, his repurchase makes it possible for him to measure any gain or loss on a subsequent sale against the new, higher cost basis of $20,000, not the original one of $2,000

Additional articles. A reminder for accountants who would welcome advice on how to alert clients to tactics that trim taxes for this year and even give a head start for next year: Delve into the archive of my articles (more than 250 and counting). 

About Julian Block

Julian Block

Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes” (Wall Street Journal), and “an authority on tax planning” (Financial Planning magazine). More information about his books can be found at julianblocktaxexpert.com

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