Key Takeaways
Donor advised funds can help investors coordinate charitable giving with their tax and investment planning.
- Appreciated stock can provide two potential tax benefits. Investors may generally deduct the fair market value of qualifying long-term appreciated securities, subject to applicable limitations, while avoiding recognition of the embedded capital gain.
- A donor-advised fund separates contribution timing from grant timing. An investor can contribute assets in one tax year and recommend grants to charities over subsequent years.
- The asset selected for donation matters. Giving highly appreciated securities can remove embedded gains from a taxable portfolio and support diversification or rebalancing.
For a charitably inclined investor, every security in a taxable portfolio has four potential destinations: hold it, sell it, harvest the loss, or give it away.
That fourth option can be especially valuable for highly appreciated stock. Selling a low-basis position creates a taxable capital gain. Contributing qualifying appreciated shares directly to a donor-advised fund can potentially avoid recognition of that gain while preserving a charitable deduction based on fair market value, subject to applicable tax rules.
For investors who already intend to give, the question is bigger than how much should we donate? An equally important question is which assets should fund the donation?
The Mechanics of Donating Appreciated Stock
Suppose an executive owns stock purchased years ago for $20,000 that is now worth $100,000. The position contains an $80,000 unrealized capital gain.
Selling the shares generally converts that unrealized gain into a taxable realized gain. Holding them preserves the tax deferral but also retains the investment exposure.
If the investor already plans to give $100,000 to charity, there is another option: transfer the shares directly to charity or a donor-advised fund.
That can remove the $100,000 position, including its $80,000 embedded appreciation, from the taxable portfolio without the investor personally realizing the gain.
This concept has support in investment research. Sosner, Gromis, and Krasner studied charitable giving within direct-indexing portfolios and found that contributing appreciated stock can significantly increase the long-run tax benefits available from those strategies.
The insight extends beyond direct indexing. When charitable intent already exists, the securities selected for donation can become part of portfolio management.
At True Wealth Design, we approach investing with the guiding principle that investment, tax, and financial-planning decisions should work together. Our guide to the basics of tax-efficient investing discusses the same principle across tax-loss harvesting, asset location, and gifting strategies.
How Donor-Advised Funds Work
A donor-advised fund, or DAF, is a charitable account maintained by a sponsoring 501(c)(3) organization.
According to IRS guidance on donor-advised funds, the sponsoring organization takes legal control of contributed assets, while the donor generally retains advisory privileges regarding investments and future grants.
Contributions are irrevocable. Once assets enter the DAF, the donor cannot take them back for personal use. The donor can, however, recommend grants to eligible charities over time.
This separates two decisions that otherwise occur together:
When do we make the charitable contribution?
When do we want individual charities to receive the money?
A family that normally gives $30,000 annually, for example, might contribute several years of planned giving to a DAF during a strategically selected tax year and continue recommending $30,000 of annual grants afterward.
Why Is Appreciated Stock More Tax-Efficient Than Cash?
Qualifying appreciated stock can potentially provide a charitable deduction based on fair market value while allowing the donor to avoid realizing the stock’s embedded capital gain. Cash may provide the charitable deduction, but it does not remove an unrealized gain from the investor’s portfolio.
Let’s revisit our example of an investor who wants to contribute $100,000. One option is $100,000 of cash. Another is $100,000 of publicly traded stock purchased for $20,000 and held for more than one year.
Under applicable rules for capital-gain property, qualifying appreciated securities may generally be eligible for a charitable deduction based on fair market value, subject to important limitations and exceptions described in the IRS Form 8283 instructions.
For illustration, assume the $80,000 gain would otherwise be taxed at the 20% federal long-term capital-gains rate. Selling the shares would create $16,000 of federal capital-gains tax before considering the potential 3.8% Net Investment Income Tax or applicable state taxes. Transferring the appreciated shares directly could avoid realizing that gain.
The actual benefit varies by taxpayer. The point is that two $100,000 charitable gifts can produce meaningfully different tax outcomes depending on what asset funds the gift.
Donating Stock Can Also Improve The Portfolio You Keep
If an investor gives $100,000 of stock rather than $100,000 of cash, the cash remains available.
It could be invested in a diversified portfolio, used for another financial goal, or deployed to purchase investments at today’s cost basis.
This can be particularly useful for executives and other investors with concentrated stock positions. Instead of selling every appreciated share needed to diversify, the investor can potentially direct some highly appreciated shares toward an existing charitable objective.
The tax characteristics of individual securities can therefore influence their best use. A loss position may offer tax-loss harvesting value. A security with modest appreciation may be relatively inexpensive to sell. A highly appreciated position may have greater planning value as a charitable contribution.
The direct-indexing research we cited earlier illustrates another benefit. Over time, successful taxable portfolios tend to accumulate appreciation, leaving fewer opportunities to harvest losses. Charitable giving strategies can remove selected low-basis positions, while cash that otherwise would have been donated can potentially be invested at a fresh cost basis.
Donor-Advised Funds Can Be Useful In High-Income Years
DAFs can be especially useful for professionals, executives, and business owners whose taxable income varies substantially from year to year.
A large bonus, business transaction, Roth conversion, equity-compensation event, or unusually profitable business year may create an opportunity to accelerate planned charitable contributions.
Suppose a couple normally gives $40,000 per year and expects to continue doing so for five years. Rather than automatically contributing $40,000 each year, they could evaluate contributing several years of intended giving to a DAF in one strategically selected year.
The contribution may generate a deduction in the year it is made, subject to applicable limitations, while the family continues recommending grants to charities over the following years.
The strategy is often called bunching charitable contributions.
Current IRS Publication 526 explains that deduction limits vary by the type of property contributed and recipient organization. Qualifying capital-gain property can be subject to a 30% of adjusted gross income limit in certain circumstances, with qualifying excess contributions generally eligible for carryforward under applicable rules.
The amount contributed to a DAF should therefore be coordinated with taxable income, existing charitable carryforwards, portfolio gains, other deductions, and the investor’s multiyear tax plan.
Is A Donor-Advised Fund Worth It?
A donor-advised fund can be particularly useful for investors who give meaningful amounts to charity on a recurring basis, hold appreciated investments in taxable accounts, or want to concentrate charitable contributions into selected tax years.
There are tradeoffs. DAF contributions are irrevocable. Sponsors charge fees and differ in their investment choices, minimums, grant procedures, and policies for accepting noncash assets. For an investor making occasional small cash donations, those additional layers may provide little value.
But for a family with substantial taxable wealth, appreciated securities, and an established charitable plan, a DAF can provide a more efficient way to coordinate philanthropy with tax and portfolio management.
Coordinate Charitable Giving With The Rest Of Your Portfolio
A charitable contribution affects more than the charitable deduction. It can change portfolio concentration, cost basis, embedded gains, liquidity, and future tax exposure.
Investors already using tax-loss harvesting, direct indexing, or other tax-aware investment strategies should therefore coordinate charitable giving with those efforts. Our article The Key to Tax-Aware Investing & TALS™ explores the broader principle of managing investments with after-tax outcomes in mind.
Execution also matters. Holding periods affect deduction treatment. AGI limitations can restrict the current-year deduction. Noncash gifts can require additional documentation and Form 8283 reporting. And when the objective is to avoid realizing an embedded gain, the investor generally wants to transfer appreciated securities directly rather than sell them and contribute the cash.
Year-end transfers should also be initiated early enough for custodians and DAF sponsors to complete them.
Make Charitable Giving A Coordinated Wealth Decision
For investors with substantial taxable portfolios, charitable planning should address three questions:
How much should we give? What should we give? When should we give it?
Writing a check may provide a charitable deduction. Contributing qualifying appreciated stock to a donor-advised fund can potentially provide a similar deduction while also removing embedded capital gains from the portfolio.
That brings us back to the four choices available to a tax-aware, charitably inclined investor: hold, sell, harvest, or give.
The appropriate choice depends on the investment, its cost basis, your tax situation, your charitable intent, and your broader financial plan.
Our role at True Wealth Design is to help coordinate those decisions. If you have appreciated securities and an established charitable-giving plan, contact a True Wealth Design professional to explore how charitable giving can fit within your tax, investment, and wealth strategy.
