• Portfolio Strategies
  • Tax Breaks for Contributions of Appreciated Property

    by Julian Block

    Tax Breaks For Contributions Of Appreciated Property Splash image

    When we contribute to our favorite charities, most of us go the easiest, most familiar route and simply write checks or use credit cards. We receive income tax deductions; the charitable organizations receive money.

    But donors who want to make major gifts and also lose less to the Internal Revenue Service should familiarize themselves with other, often-overlooked ways to fund philanthropies. One option that allows the charitably inclined to realize significant tax benefits is to donate appreciated properties that have been owned for more than 12 months and that will be taxed as long-term capital gains when sold. Some common examples of investments that might fit this profile are shares of individual stocks, mutual funds and exchange-traded funds (ETFs); bonds; and real estate.

    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 sales of investments, effectively decreasing the cost of donations. But if the investors sell their holdings first and then donate the cash proceeds, the IRS will pocket a chunk of the profits.

    For 2012, the top rate for long-term capital gains is 15% for individuals in income tax brackets of 25% or higher (taxable income above $70,700 for married taxpayers filing joint returns and above $35,350 for single filers). The rate is 0% this year for individuals in the two lowest income tax brackets of 15% and 10% (taxable income below $70,700 for joint filers and below $35,350 for single filers). The top rates of 15% and 0% apply through 2012. Add to Uncle Sam’s take whatever his nephews and nieces exact for taxes at state and local levels.

    A Deduction for All Taxpayers

    Donations of appreciated assets might seem to be an appropriate technique only for the very affluent, but it can also benefit people of more modest means.

    To show you an example of how the numbers look, let’s say Elijah Vennebush intends to fulfill a $10,000 pledge to Roosevelt University. His long-term holdings include shares of stocks that he acquired for $4,000, and that he is now about to unload for $10,000. To reap a perfectly legal double benefit, Eli should contribute stock worth $10,000, instead of making a cash donation of $10,000.

    Going the stock route makes no difference to Roosevelt University, a tax-exempt entity that incurs no taxes when it sells the shares and ends up with close to the same amount of money. But it does make a decided difference in the size of Eli’s tax tab. A charitable gift deduction of $10,000 cuts taxes by $3,000, assuming Eli falls into a combined federal and state tax bracket of 30%. In addition to that, he sidesteps forever the taxes that would be due on the $6,000 gain if he were to sell the stock—a federal levy of as much as $900 (15% of $6,000) and whatever his state exacts.

    A common situation is that Eli is at “sixes and sevens” about whether to relinquish his position in the appreciated stock. Also, he may be wondering if his asset allocations need a makeover. I would suggest that Eli ought to donate the stock to Roosevelt in spite of these questions and use the money that he would have donated to buy back the shares at their current market price. That way, he preserves a contribution deduction of $10,000 and dodges the tax he would have to pay were he to sell and realize the $6,000 worth of capital gains that the shares have appreciated by since he acquired them.

    Even better, Eli reaps a benefit other than the deduction and diversification of his holdings. Brokerage commissions aside, a repurchase of the stock makes it possible for him to measure any gain or loss on a subsequent sale against the new, higher cost basis of $10,000, not the original one of $4,000—a tactic sanctioned by the IRS.

    Concerns and Complications

    There are other concerns and complications to mull over—which is to be anticipated, given continual changes to an already arcane Internal Revenue Code. For starters, the additional tax break is available only for donors who hold their shares in taxable accounts, not traditional IRAs or other kinds of tax-deferred retirement plans.

    Assets Held for Less Than a Year

    Also, the IRS does not look kindheartedly on donations of assets owned less than 12 months. IRS examiners place a ceiling on Eli’s charitable write-off. The cap is what he paid for the shares or their current market value, whichever is less. The IRS is uncompromising even though the shares are worth more when he gives them away. With shares that have gone up a lot—and swiftly—that stings. Unsurprisingly, the tax laws set other snares for Eli as he navigates this limitation.

    Suppose he purchased some of those shares two years ago and purchased additional ones last month or, in the case of mutual funds, acquired additional shares less than 12 months ago through automatic reinvestments of distributions of capital gains and income (dividends or interest paid by the securities held in the fund). The IRS allows the current value deduction only for his two-year-old shares and limits the deduction for his newer shares to their purchase price.

    End-of-Year Fund Distributions

    Lots of people make their major donations in December, when they have fine-tuned their end-of-year planning. Every year, many December donors of mutual fund shares find out the expensive way about some gritty details.

    For instance, Eli has a taxable account with the fictional Hoover Fund. He plans to give some of his shares to Roosevelt around the close of the year. Like most other fund companies, Hoover distributes capital gains and income sometime in December, a payout that goes only to investors who own shares on what is known in fund-speak as the “ex-dividend date.” The distribution reduces the fund’s net asset value and forces Eli to pay taxes on part of the fund’s gains, even if he hasn’t sold any shares. This holds true even though Hoover distributes additional shares that are reinvested, not cash. The result is that Eli incurs unnecessary taxes on some of his own capital without any real increase in his investment—and his subsequent donation deduction saves less taxes.

    Fortunately, Hoover makes it easy for its investors to determine the dates and anticipated amounts of distributions. In common with many other fund companies, Hoover regularly posts payout estimates on its website weeks or months before it makes them. Given the fund’s track record of price volatility, those postings caution that actual amounts might greatly exceed estimates. This concern can be set aside as long as Eli donates before the ex-dividend date, since doing so allows him to hang onto the maximum tax break.

    Completion Date of Gifts

    To ensure that donations of appreciated stocks or other assets count as deductions for the current year, Eli must complete the gifts by December 31. He needs to keep in mind that the legal paperwork can take longer than simply mailing checks, charging donations on credit cards, or making those routine account-to-account transfers that move shares out of his brokerage account and into Roosevelt’s account.

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    Suppose Eli needs to deliver or mail a properly endorsed stock certificate to Roosevelt. The donation is considered completed on the date of delivery or mailing, provided Roosevelt receives the certificate in the ordinary course of the mail.

    Stricter regulations apply if it proves necessary to deliver the certificate to Eli’s bank, to his broker, or to the issuing corporation as his agent for transfer into the name of Roosevelt. The regulations specify that the donation isn’t completed until the date the stock is transferred on the corporation’s books—a process that could take quite a while.

    The need to keep an eye on the calendar was made expensively clear to Joseph Alioto, a lawyer and former mayor of San Francisco, who donated real estate. The Tax Court held that he didn’t complete his donation by December 31 of the year under review. While the deeds were executed in December, they weren’t recorded until well beyond the close of the year, and the recording date constituted the delivery date.

    Additional Requirements and Pitfalls

    IRS guidelines spell out how a taxpayer is supposed to determine the actual value of shares transferred. For shares of publicly traded companies, you must use the average of a stock’s high and low prices on the date of delivery—for instance, the average would be $90 when the high is $100 and the low is $80. For mutual fund shares, you must use the fund’s closing price on the date of delivery. As for shares of non-listed companies, the value is what you would receive from a third party in an arm’s length transaction, a determination that might require you to obtain a written opinion from a qualified appraiser.

    It’s a good idea to check with a tax expert before making sizable contributions, especially if you plan to donate appreciated property. The IRS wants a written appraisal when claiming a deduction of more than $5,000 for any gift of property (over $10,000 in the case of a stock in a closely held company), but the IRS doesn’t ask for an appraisal of shares of publicly traded companies. This is because the stock market determines the value of publicly traded companies daily.

    The tax code clamps some ceilings on the deductions available for contributions. In general, you can deduct up to 50% of your adjusted gross income for gifts of cash to most charities, such as religious organizations and educational institutions. But the law also sets limitations of 30% or even 20% of adjusted gross income on the amount you can claim for contributions of appreciated investments. You can’t claim any gifts in excess of the limits on this year’s return, although you can claim them for as many as the next five years, subject to the annual limits (which can get rather complicated to calculate). Five years should be sufficient unless you make substantial future donations or your income nosedives.

    Sell, Don’t Donate, Investments With Losses

    Your planning comes undone if you donate stocks or other investments that have dropped in value since their purchase. Their donation date value determines the amount of your charitable deduction, not their purchase date value. Worse still, you cannot write off the losses. Instead, you should sell the investments first and then donate the proceeds. This tactic allows you to deduct the contributions and claim capital losses that reduce, or even erase, taxes on capital gains or ordinary income from sources like salaries, business profits, pensions, withdrawals from tax-deferred retirement arrangements and interest.

    As an example, let’s presume Eli’s long-term investments include shares he bought for $15,000 that are now worth $10,000. If he donates the shares, $10,000 is the cap on his charitable deduction. If Eli sells the shares and donates the proceeds, he’s able to deduct the $10,000 and claim a long-term capital loss of $5,000.

    What if his sales of investments result in no gains, or his gains are less than his losses? The law permits Eli to use excess losses to offset as much as $3,000 ($1,500 for married couples who file separate returns) of ordinary income. Any unused capital losses above $3,000 for this year can be carried forward into next year and beyond, should that prove necessary.

    Julian Block is an attorney and author based in Larchmont, New York. For information about his books, visit www.julianblocktaxexpert.com.


    Ann from CA posted over 4 years ago:

    How can I calculate the maximum to donate in appreciated mutual funds to our private medical foundation for 2011?

    The New Year's holiday prevented any mutual fund settlement between Dec. 29 and Jan 4-6.
    Will the IRS therefore refuse to allow our donation on Dec. 29?

    The current issues of AAII on taxes are great.

    Charles from IL posted over 4 years ago:

    Ann, as Julian stated in his article, the IRS uses the settlement date to determine what year the investment was transferred. Since you are donating to a private medical foundation, you may want to speak to a tax professional to confirm that this rule still applies. -Charles Rotblut

    Douglas from VA posted over 4 years ago:

    There are, or used to be, special deals for people who gave extraordinary amounts in terms of their income/assets. I have a friend who is contemplating a gift that might qualify.

    Can anybody give us some info or pointers to the appropriate regs.

    Robert from OH posted over 4 years ago:

    Do these same provisions apply to publicly traded partnerships? If not where are those rules in IRC?

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