You get the biggest benefit by getting rid of the biggest potential tax liability.
Dear Dan,
I have the cash to make a charitable donation but I caught your article about the best way to give to charity and it made me realize I should probably give shares instead. I also found helpful the article on some of the quirks of donating shares you outlined in this column about the smartest way to donate stock to charity. I’m not over 70 ½ so can’t do a donation from my IRA. I’m a little stuck on which stock to give away. I like some of these holdings and don’t want to part with them. Can you help?
Charitable in Nashville
Dear Charitable,
I’m glad those articles were helpful.
The basic strategy is to start with the stocks that have gone up the most since you bought them. You are looking for the largest paper profits, as many people would call them. Your brokerage statement should show these gains as “unrealized gains.” This is the difference between your “cost-basis” (what you paid for the shares) and the current value of the shares.
When you gift the shares, you no longer own the stock, but you no longer need to deal with the untaxed gains. You get the biggest benefit by getting rid of the biggest potential tax liability.
Here’s an example:
You said you had cash to make the donation. Let’s say you want to donate $10,000 and can pay cash or gift shares. You bought company A stock for $1,000 and it’s now worth $10,000. You also own shares in company B also worth $10,000 but you paid $8,000 for those. Both stocks have been held for more than one year making the unrealized gains long-term under the tax code.
Regardless of whether you write a check for $10,000, give away the $10,000 of company A stock or the $10,000 of company B stock, your potential charitable deduction will be $10,000, your net worth drops $10,000 and the charity now has $10,000 to further their cause. However, if you make the donation in cash, you keep $11,000 in potential gains, $9,000 in shares of company A and $2,000 in shares of company B. If you donate the shares of company B, you no longer have a potential $2,000 gain in company B but retain the potential $9,000 gain in company A. Whereas if you donate the stock in company A and you only have the gain in B left. Donating company A shares is the best choice.
You mentioned you still like some of your holdings. Well, if you like company A, you can use the $10,000 cash to buy shares in company A. This new purchase will have a basis of $10,000 so if you do sell them in the future, the gain or loss will be based on this new $10,000 purchase. Your total unrealized gain after this new purchase is just the $2,000 on company B. That is significantly better than the $11,000 in potential gains you retain if you donate cash.
Most people have many holdings bought at different times in their accounts. Every purchase of every holding, including reinvested dividends, creates a separate tax lot. These lots offer a chance to donate highly appreciated shares of more than one holding or just a few shares of any given holding. Multiple lots present more tax planning opportunities even beyond donations but that’s a topic for another day.
I gave you a simple example, but you should note the rules around charitable donations can get tricky. For instance, depending on your specifics, you may not get a deduction for the donation, or you could have your deduction limited. As a result, you should consult your adviser before making a donation to avoid surprises.
If you have a question for Dan, please email him with “MarketWatch Q&A” on the subject line. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
Originally published on MarketWatch. Read the original article here.