Why You Should Donate Stock
Donating appreciated assets is a clever way to combine the tax benefits of charitable giving with an opportunity to reduce capital gains taxes on the value of appreciated assets like stocks, bonds, mutual funds, ETFs, and other securities.
If you’ve read our post about why you should give, you know giving is something Lisa and I have done throughout our marriage.
Early on we simply wrote checks to our church or selected charity and took a deduction from our taxable income when we filed our taxes the following Spring.
Several years ago when we reached Milestone 6 (Saving for Flexibility) we didn’t really change our approach to giving at all.
Then, one day I was listening to one of my favorite financial podcasts. The topic was making the most of charitable giving and at some point, the host began explaining why you should donate stock instead of directly giving cash.
I was intrigued. We’d been donating cash (well, more like writing checks) for years, but we had some equities in taxable brokerage accounts so I was curious about what the host had to offer.
As I listened on, I learned a new approach to giving that’s totally changed our strategy for taking advantage of the tax benefits it provides.
Let me tell you more about why we donate stock instead of cash when we can.
Why Donating Stock Can be Better
Before learning about this strategy, we did all of our giving straight out of our checking account. So, the flow of cash and taxes looked something like this:
Income -> Income Taxes Withheld -> Check to Charity -> Tax Deduction Next Spring
It’s pretty straightforward. Get paid, Uncle Sam holds back his share, you donate, and next Spring you get the tax on the donated piece back.
And, if you don’t have a brokerage account in a taxable space (meaning you incur an immediate capital gains tax liability when you sell the appreciated assets), then that’s probably how you should continue to make donations.
However, If you do have a taxable account or assets you should read on.
As you know, when you sell an appreciated asset, like a stock, you owe a tax on any capital gains that are realized in the transaction. As assets grow in value, this requirement makes selling them less and less attractive.
Well, when you donate stock, you can avoid the capital gains taxes on the shares you give to charity.
“Gee whiz, Curt, that sounds great for the charity, but I was investing those shares so I could actually harvest the earnings one day.”
Good point. The concern is logical, but the good news is there’s another step that will allow you to keep your gains while still getting the tax deduction.
Previously, you would have written a check directly to the charity. In this strategy, after you donate stock, you’ll repurchase shares of the same stock you donated at the same value as the donation.
Now the transaction will look like this:
Income -> Income Taxes Withheld -> Donate Appreciated Shares to Charity -> Purchase New Shares in Equal Amount to Donation -> Tax Deduction Next Spring & Free Step Up In Basis
By repurchasing the same value of shares you’ve donated, your charity receives their donation and you still have the same value of the stock, but your tax basis for the stock has now increased to today’s market value.
This means your capital gains tax liability has now been reduced by the difference between the stock’s original cost basis and the price at which you repurchased the shares today.
To help understand this more clearly, let’s look at an example.
Phil Philanthroper
Suppose Phil Philanthroper donates $2,000 a year to the local art museum. By writing a check, Phil gets a nice little deduction for his gift by reducing his adjusted gross income (AGI) by $2,000.
But if Phil donates $2,000 of the exchange traded fund (ETF) XYZ instead, the art museum still gets the full value of the donation, Phil still gets the tax deduction, but Phil can redirect the $2,000 he normally gave out of his checking account to buy more shares of XYZ.
The result is Phil receives a free step-up in the price basis of the shares he owns while still owning $2,000 of XYZ.
To carry this example further let’s assume XYZ was worth $80/share when Phil bought it but had appreciated to $100/share when Phil donated it.
Since Phil donated 20 shares ($2,000 at $100/share) he avoids capital gains tax on $400 of appreciation (20 shares at $20 of gains/share). If Phil is in the 15% capital gains bracket, this means Phil just saved $60 simply by making his gift a little differently.
This is a simple example with small dollars. The more you donate and the more regularly you give, the more valuable this technique becomes.
Donate Stock to Help with Reallocation Too
Another strategic opportunity this method creates is allowing you to adjust your asset allocation without incurring capital gains taxes.
Let’s assume you have a goal to own 60% stocks and 40% bonds in your brokerage account. Over the last several years the stock market has been on a real tear and your asset allocation has shifted to 70% stocks and 30% bonds.
Ordinarily, you’d have to sell some stocks and buy some bonds or just buy a lot of bonds to get back to your 60/40 goal.
If you sell stocks to buy bonds, you’ll owe capital gains tax and it may not be convenient to buy a bunch of bonds to get things back in line.
Well, if you donate stock and rebuy bonds instead, you’ve effectively reduced your stock holdings, increased your bond holdings, and done so without incurring any additional tax or having to invest any additional cash into your brokerage account.
Oh, and your favorite charity sends you a Christmas card.
Other Tidbits About Donating Assets
- This strategy only works for long-term holdings, which means you need to own the donated security for at least one year to claim a deduction.
- If you donate shares owned less than one year, only the cost basis of the shares is deductible.
- You wouldn’t want to donate shares that have lost value (depreciated). You should look into tax loss harvesting those instead.
- Donate shares with the largest unrealized gains first to maximize the value of the step-up. This may not be the order in which the shares were purchased, so investigate this carefully.
- Deductions for securities donations are limited annually to 30% of the donor’s adjusted gross income (AGI).
- Get a receipt from the charity for your records. It may not contain an actual dollar value for the stock, only the number of shares received. The value of the donation will be the average of the stock’s price between its market high and low on the day it was donated.
FAQ’s
Can I donate any stocks?
Yes, but you’ll only want to donate shares that you’ve owned for at least one year for this strategy. Donating short-term holdings (those you’ve owned less than one year) only allows you to receive a tax deduction on the cost basis, not any growth in its value since the purchase.
Can I donate bonds?
Yes. This strategy can work for basically any asset or security.
Is there a limit?
Technically no. Generally, you can deduct securities donations up to 30% of your adjusted gross income and cash up to 60% of your AGI. You can donate as much as you want, but beyond these limits, it won’t be deductible.
How do I donate securities?
Reach out to your brokerage. Odds are they’ll have a way to do this online. You will need to reach out to your charity to find out how they want to receive the donation. In many cases, they’ll use a bank or broker to liquidate the shares.
Which securities should I donate first?
Donating the shares with the largest capital gain first will produce the greatest tax benefit. As a rule of thumb, you should start by donating the most appreciated shares and work your way down to those that have increased in value the least.
