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If you're giving to charity out of your bank account or with cash, you need to watch this video. I'm going to tell you about another way to give that could save you money on taxes and allow you to give more money to your favorite charities without impacting the rest of your life. And who doesn't want that?
Now, lots of studies show the positive effects of charitable giving on the person doing the giving, not to mention the good being done by the charities they support. Generosity is positively associated with happiness, contentment, and overall well being. And in my opinion, charitable giving is one of the best things you can do with your money, and it plays an essential role in financial independence.
All that to say, reducing taxes is not the reason we give, but it's a nice byproduct.
The way most people give is with their bank account. They transfer money to their charities of choice on an occasional or recurring basis.
But the better way to give is with appreciated assets. And by appreciated assets, I mean something that has gone up in value since you bought it. Now that could mean a privately owned business, real estate, cryptocurrency. Or more commonly, in what I'm going to be talking through today, stocks and bonds. And let me explain why this is the best way to give to charity.
If I own an asset that has gone up in value, I'm going to pay taxes on that increase in value when I eventually sell it. And this is called capital gains tax.
But if I donate that asset to charity without selling it first, the capital gain is wiped away and I won't pay taxes on it. Plus I get an itemized tax deduction for the full value of the asset I transferred, including the gain that I was never taxed on.
Say I want to give $10,000 to charity this year. I have $10,000 available in my bank account that I could give, but I also have a taxable investment account where I bought a stock for $5,000, held it for at least a year, and now it's worth $10,000.
So there are a few options. I could give the $10,000 from my bank account, but then I still have that $5,000 capital gain that I'll have to eventually pay taxes on. I could also sell that appreciated stock and give that money to charity. But then I'm going to owe taxes on that $5,000 gain.
The best option would be to give that stock directly to charity. I would transfer it to them and then they would sell it. That way I give $10,000 and I wiped out that $5,000 capital gain. If I still wanted to own that stock, then I could use the $10,000 that's in my bank account to buy it. So, I still own $10,000 worth of stock, but I just eliminated that taxable gain.
I can also get an itemized tax deduction for the full value of the stock I transferred, or $10,000.
A few important things to note with this strategy.
Number one, this is only for regular taxable investment accounts. You may see this called a brokerage account, an individual account, a transfer on death account, or a joint account. This strategy is not one to use with 401ks, IRAs, or Roth IRAs.
Number two, it's really important that you transfer the stock directly to charity rather than selling it first. If you sell it while you still own it in your account, you're going to pay capital gains taxes.
Number three, you only want to transfer shares that have gone up in value. If you own something that's gone down in value, you could sell that asset while you still own it. which would bring a capital loss to your taxes and it could reduce your taxable income for that year.
You may be thinking this all sounds great, but if I'm giving on a recurring or semi-frequent basis It's going to be a pain to transfer those appreciated assets every single time. And I hear you. That's where a donor advised fund comes in.
I talked about donor advised funds in my last video on bunching charitable contributions to maximize your itemized tax deductions, but I'm going to cover them again here because I think they're a super powerful tool in your charitable giving tool belt.
A donor advised fund is a personal charitable investment account. When you contribute money to a donor advised fund, you're making an irrevocable gift to charity, and that means you can't pull money out of this account for any purpose other than giving it to charity.
You can advise on how the money within your donor advised fund should be distributed to charities over time, and you get your tax deduction when the money goes into the donor advised fund, not when it's eventually sent out of the donor advised fund to the various charities.
And the charities you're supporting need to be IRS qualified public charities. which would include most churches, universities, and other 501c3 organizations.
Using a donor advised fund to donate your appreciated assets simplifies the process a lot. Instead of transferring the stock to your charity directly, you can transfer it into your donor advised fund.
And the amount transferred to the donor advised fund becomes your charitable donation for tax purposes, just as if you had given that money to charity. But then you can send the money out of your donor advised fund on your schedule.
And rather than transferring the stock from your donor vice fund to your charity, you can sell the amount you want to give within the Donor Advised Fund and transfer dollars to your charity instead.
By using the Donor Advised Fund to facilitate this process, it means you need to do the paperwork in coordination much less frequently. Once per year at the most, but maybe even less if you're using a bunching strategy or giving out on a less frequent basis. And the great thing is, you can still give to your charities on a monthly or recurring schedule out of the donor advised fund.
Also, you can keep the money within your donor advised fund invested and growing, and any gain on your investments in that account is completely tax-free.
The best assets to transfer to your donor advised fund for charitable giving are the assets that you’ve held for at least 1 year, and have appreciated the most on a percentage basis, not on a dollar basis, because we want as much of our charitable donation to be capital gains as possible, as opposed to principal or cost basis. That's going to eliminate the most in future taxes.
Let's look at an example. Assume we want to give $10,000 in charity and we have this stock A, which we bought 100 shares at $50 a share for a total of $5,000. Now those shares are worth $100 per share or $10,000 total. That means our gain on stock A is 100%.
We also own stock B. We bought 300 shares at $60 per share for a total of $18,000. The share price has grown and now it's worth $100 per share as well for a total of $30,000. So our gain on stock B is 67%.
To give $10,000 to charity, I can either transfer 100 shares of stock A or 100 shares of stock B.
If I transfer 100 shares of stock A, my $10,000 gift will be composed of $5,000 of principal, which is what I paid for the shares. and $5,000 gain.
If I transfer 100 shares of stock B, my gift is going to be composed of $6,000 of principal and only $4,000 of capital gains.
Our goal is to have as much of our gift be capital gains as possible so we'd rather donate stock A. Because it appreciated the most on a percentage basis, it's going to have the highest portion of capital gains.
Now we understand the power of donating appreciated assets to lower your future tax bill. We also know how we can use a donor advised fund to make this process easier.
You can pair this strategy with a bunching strategy to make your charitable giving extremely tax efficient.
As always, it's important to consult with a financial advisor before making any changes to your financial plan. If you don't have a financial advisor you're working with currently, Trek Wealth Planning may be able to help.
We provide comprehensive financial planning, which includes getting a tax efficient-charitable giving strategy in place. Schedule a free consultation to see how we can help.
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