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A Year for Generosity

Julian Block  |  October 31, 2017

MANY OF MY CLIENTS make donations to their favorite philanthropies in the final months of each year. With lower tax rates in the offing, this could be a good year to make such gifts—especially for those who have appreciated property to donate.

Many clients reflexively write checks, as that’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 property 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.

An 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 that 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 2017 tax year, Alex 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 federal taxes of $2,700 (15% of the $18,000 profit) on the gain from the LGA sale. (Like most other individuals, Alex’s federal long-term capital gains rate is 15%. The rate goes as high as 23.8% for those who are in the top ordinary income-tax bracket of 39.6% and subject to the 3.8% Medicare surtax on investment income.)

As a less taxing alternative, I advise Alex to 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. First, 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. Second, Alex shouldn’t donate depreciated shares or other losing 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.

That brings us to 2017. President Trump is adamant that his top priority is to lower tax rates. If he and Congress cut that kind of deal, when would the reduced rates take effect? Probably prospectively, beginning with 1040 forms for the 2018 tax year, which will be filed in 2019, a change that could cause Alex’s bracket for 2018 to drop below 35%.

What to do? I recommend Alex accelerate into 2017 donations that he intends to make in 2018. But, you might wonder, what difference does it make when he deducts his charitable donations? By donating in 2017, Alex garners the tax savings one year sooner—and, as an added bonus, he applies his donation deductions against higher-taxed 2017 income, instead of lower-taxed 2018 income.

Julian Block writes and practices law in Larchmont, NY, and was formerly with the IRS as a special agent (criminal investigator). His previous articles include Unending Pain and Capital Punishment. This piece is excerpted from Julian Block’s Year Round Tax Strategies, available at JulianBlockTaxExpert.com. Follow Julian on Twitter @BlockJulian.

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