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Gifts of Appreciated Securities Back in Style?

The surge in the stock market since last March may have given new life to a traditional charitable giving strategy:  Gifts of securities with long-term capital gain.  Clients who are considering year-end contributions as part of a strategy for reducing 2009 taxes should be reminded that they will usually be better off giving appreciated stocks, bonds and mutual funds, rather than cash.
           
Roger tells his adviser that he intends to write a check for $10,000 to his favorite charity, but the adviser happens to know that Roger owns stock that has jumped 35% in value since he bought it in October 2008.  “Give the charity $10,000 worth of your stock,” the adviser implores, “and you’ll have a $10,000 deduction, plus capital gains tax savings.”
           
“But I love that stock,” Roger complains, to which the adviser responds that Roger can give the stock and use the $10,000 in his checking account to repurchase shares in the same company.  “That way, you’ll have a new basis in the stock that will save taxes when you sell – which may be especially important if and when the capital gains tax rate goes up to 20%.”

Gifts of long-term capital gain property are deductible up to 30% of a donor’s contribution base (adjusted gross income), with a five-year carryover for excess deductions.

 

 

Guidelines on Gifts of Appreciated Property

Clients should consider giving long-term capital gain property of all kinds, including marketable securities, closely held stock, real estate and tangible personal property, such as paintings, antiques, coin collections, etc.  However, certain deductions may have to be reduced:

Contributions of “ordinary income property” must be reduced by the amount of ordinary income or short-term capital gain that would be realized if the property were sold at its fair market value [IRC §170(e)(1)(A)].  Examples include inventory, a work of art in the hands of the artist who created it, tangible personal property that has been depreciated, real property that has been subject to depreciation in excess of straight-line and short-term capital gain property.  Gifts of appreciated assets other than marketable securities require qualified appraisals where the deductions claimed exceed $5,000 ($10,000 for closely held stock).

If an individual contributes tangible personal property to a charity, he or she must reduce the amount of the contribution by 100% of the long-term capital gain element in the property if the charity puts the property to a use unrelated to its charitable purposes [IRC §170(e)(1)(B)(i)].  So if Susan gives a painting to her college and the college sells the painting, she can deduct only her cost basis.  Upside: reduced deductions qualify for the 50%-of-AGI deduction ceiling.

Gifts of mortgaged property are treated as “bargain sales” to charity, with the mortgage debt being considered an amount realized by the donor.  Two results: (1) The donor’s contribution is reduced by the amount of the outstanding debt, and (2) the donor must report a pro-rata share of the capital gain equal to the ratio the debt bears to the fair market value of the property [IRC §1011(b)].

 

Algebraic Solution to Charitable Gift Challenge

Suppose that your client (25% tax bracket) owns 100 shares of XYZ stock, each share having a value of $100 and a basis of $60. He wants to sell part of the stock and give the other part to charity, so that the tax savings from the deduction will offset the capital gains tax he’ll realize from the sale.

Question: How many shares should he sell, and how many shares should he donate? 

Let “G” represent the long-term capital gain your prospect will realize from the sale. If “D”
represents his charitable deduction for the contributed stock, then we want .25D to equal .15G. Let “N” represent the number of shares your prospect will sell. Obviously (100 - N) is the number of shares he’ll contribute.  The gain per share your prospect will realize from the sale will be $40. The deduction per share your prospect will be allowed for the contribution will be $100.

Thus, we can say that G = $40 x N, and D = $100 x (100 - N).

Plugging these expressions into the equation .25D = .15G, we get $25 x (100 - N) = $6 x N. Or, 6N = 2,500 - 25N, and 31N = 2,500, so N = 80.6 shares.

This means your client should sell 80 shares and give 20 shares to charity. Proof: If he sells 80 shares, his long-term capital gain tax will be 80 x $40 x .15, or $480. The contribution of 20 shares will produce a charitable deduction of $2,000, which saves $500 in taxes in a 25% bracket. In determining “N,” we rounded down to the nearest whole share.

 

 

Unitrusts Offer Cleansing Solution for Capital Gains

Charitable remainder trusts offer two major tax advantages:  tax deductions and avoidance of capital gains taxes when assets are sold within the trust.  Capital gains tax avoidance can be especially important where the applicable tax rate is 28% (collectibles) or 25% (real estate subject to depreciation recapture) or where short-term capital gain is present.  Charitable deductions are reduced when 28% property or short-term gain assets are contributed, but clients sometimes are more interested in capital gains tax savings than charitable deductions.

Here’s a fairly typical example.  Hermione purchased shares in an emerging markets stock index mutual fund just over a year ago.   She paid $130,000, but now the shares are worth more than $200,000.  Hermione knows that the emerging markets fund eventually may go down in value, and feels she needs to diversify her holdings – but that would mean paying capital gains taxes on $70,000.  It so happens that Hermione also has wants to make a contribution that would eventually provide for three organizations that she supports.

Hermione may be an ideal candidate for a charitable remainder unitrust.  By transferring the mutual fund shares to a unitrust, several appealing results occur:

• The trustee sells the stock and reinvests in a diversified portfolio, without paying capital gains taxes;
• Hermione selects an annual payment amount of 5% of the value of the trust, as revalued every year; the trustee will send quarterly checks to Hermione and then to her husband, Fred, if he survives her;
• About one-third of her trust gift will be tax-deductible (based on the selected payout rate, ages of the trust beneficiaries, frequency of payments and the applicable §7520 rate);
• Hermione keeps the right to make additional gifts to the trust whenever the need or desire arises. 

When the trust ends, everything passes to charitable remainder beneficiaries named by Hermione.

 

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