Tax Gain Harvesting and Donor-Advised Funds

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Topic Author
Cash
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Tax Gain Harvesting and Donor-Advised Funds

Post by Cash »

Although I knew about donor-advised funds ("DAFs") and how one could take a deduction in one tax year but not distribute the contributions until subsequent tax years, and although I knew one could donate appreciated stock directly to charity to avoid paying capital gains, I never put the two together until livesoft referenced doing so in passing in another thread. After reading the wiki and several DAF threads that have been posted since 2007, this concept does not appear to be novel, yet I am surprised that the advice to donate securities with long-term capital gains to a DAF is not given more often to people in the higher tax brackets. Am I missing something? Just as most would agree that it is a mistake for someone to forego significant TLH opportunities, is it likewise a mistake for someone who intends to donate to charity to forego significant tax-gain-harvesting ("TGH") opportunities to donate appreciated securities and then immediately repurchase those shares using available funds?

Of course, a large limiting factor, and perhaps why it is not discussed more often, is the amount one intends to donate to charity. I came across a poll indicating that most forum members do not donate very much, if anything, to charity. If you have no intention of donating to charity, then TGHing to a DAF likely is a losing proposition financially. Similarly, it probably does not make sense to TGH indiscriminately even if you do intend to donate to charity. For instance, if someone making $100,000 per year intends to donate 10% to charity, then TGHing should be limited to $10k unless the person is bunching deductions into alternate years or anticipates being in a lower income tax bracket in the future. Nevertheless, TGHing to a DAF appears to be a very attractive proposition for maximizing tax deductions for charitable contributions.

tl;dr: Is there any reason someone in a high tax bracket should not regularly TGH securities with long-term capital gains by donating them to a DAF up to the amount one anticipates will be given to charity over a 1-2 year period?
Sidney
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by Sidney »

There are a number of ways the bunching strategy can work. It can be especially useful for people about to retire who expect that their tax rate will be very low after they quit work. I retired at 55 and my pension doesn't start until 65. During my last full year of work when my tax rate was at the maximum, I prefunded approximately 10 years of charitable donations to a Charitable Gift Account with appreciated securities.
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livesoft
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by livesoft »

Since one can donate shares directly to the charity of your choice, one should have other reasons to have a DAF. Also note that any gains in the shares once in the DAF are not deductible. That is the fair market value on date of donation is what you get for a deduction and not the value of when you direct a donation from the DAF.

So we use a DAF for a couple of reasons:
(1) We wish to bunch deductions into every-other year on our tax return: standard deduction in odd years, itemize in even years. So we do not wish to give charities shares from our portfolio in odd years. Instead we give to the DAF in even years, then have the DAF make contributions to charities in odd years. We do give to charities directly in even years.

(2) We wish to give sub-$1000 amounts to many causes, so a DAF is simpler than donating shares for these smaller amounts, but not as simple as just donating cash.

In any event, we use a mix of direct donations and donations from the DAF. I don't care what happens to the investments in the DAF as I want them to go to charities within a year anyways.
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Topic Author
Cash
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by Cash »

livesoft wrote:Also note that any gains in the shares once in the DAF are not deductible. That is the fair market value on date of donation is what you get for a deduction and not the value of when you direct a donation from the DAF.
Fair enough, though the impact of that is not so clear. Say you have $1000 in cash to give to charity every year. In 2012, you donate $1000 from fund X, then use cash to repurchase $1000 in fund X. After one year, the donated shares are worth $1100. However, the repurchased shares are also now worth $1100, so you donate that lot to charity and replace it with $1000 cash. Thus, you are able to deduct $1000 in 2012 and $1100 in 2013 = $2100 total deduction. If you had not donated to the DAF and held onto fund X for an additional year, you would have been able to deduct the $1000 cash donation in year 1 + $1100 of fund X in year two = $2100. So it's a wash for you. The alternative is not to donate cash in year 1, but instead to buy an additional $1000 in fund X in 2012 and donate the entire $2200 position in 2013. In that case, you are better off not donating in year one. But you also could have been worse off if the value of fund X had fallen.

I think I'm fine not worrying about gains or losses in the DAF once the donation is made. In that sense, it's no different from donating directly to a charity.
So we use a DAF for a couple of reasons:
(1) We wish to bunch deductions into every-other year on our tax return: standard deduction in odd years, itemize in even years. So we do not wish to give charities shares from our portfolio in odd years. Instead we give to the DAF in even years, then have the DAF make contributions to charities in odd years. We do give to charities directly in even years.
This is a good strategy that I might also employ.
(2) We wish to give sub-$1000 amounts to many causes, so a DAF is simpler than donating shares for these smaller amounts, but not as simple as just donating cash.
This is also the appeal for me: I suspect several charities have difficulty processing share donations. But it's better than cash because we avoid the capital gains tax.
In any event, we use a mix of direct donations and donations from the DAF. I don't care what happens to the investments in the DAF as I want them to go to charities within a year anyways.
I'm open to allowing a portion of the contributions to accumulate. Why not? Of course, they could also depreciate. But similar to my own investments, I would expect appreciation over the long term.
Wagnerjb
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by Wagnerjb »

Sydney and Livesoft have given you real-world examples of how a DAF can help - in pre-retirement year, and with every-other-year bunching, respectively. Let me offer another example. That is, for an individual whose tax rate changes. It can change if your income is substantially different from one year to another - for example to due a large bonus or exercising stock options. Or it can increase or decrease due to changes in tax laws.

Best wishes.
Andy
FrysS
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by FrysS »

I was reading this thread and it hit me that what livesoft and other suggest (grouping charitable contributions every other year) make perfect sense. Why didn't I think of this before! Now, my question has to do with donating appreciable securities. If I have receive ESPP shares, normally I sell them immediately. This causes a small capital gain or loss (depending on how long the sale takes to clear) and also tax due on the discount at ordinary income tax rate. If I donate the ESPP shares, can I save paying all the tax? Or would I still have to pay the ordinary income tax rate on the discount?

Sorry for threadjacking!
JDCPAEsq
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by JDCPAEsq »

FrysS wrote:I was reading this thread and it hit me that what livesoft and other suggest (grouping charitable contributions every other year) make perfect sense. Why didn't I think of this before! Now, my question has to do with donating appreciable securities. If I have receive ESPP shares, normally I sell them immediately. This causes a small capital gain or loss (depending on how long the sale takes to clear) and also tax due on the discount at ordinary income tax rate. If I donate the ESPP shares, can I save paying all the tax? Or would I still have to pay the ordinary income tax rate on the discount?

Sorry for threadjacking!
No, you can only deduct fair market value if the shares have been held long term.
John
letsgobobby
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by letsgobobby »

I also learned this from bogleheads and now do this exclusively. It is much easier to make a single donation of appreciated shares every year or two to our DAF than to try to donate 1 or 10 shares to multiple small charities. I used to make donations by credit card for the rewards, but I was willing to give up the 1-2% to save so much hassle, not to mention saving my charities the credit card processing fees. And because of the kind of mental accounting I do, donating appreciated securities does not impact my monthly cash flow at all, and I can still save my budgeted amount each month.
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altruistguy
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by altruistguy »

Hello,

I recommend that all of my clients who both (a) make material cash donations to charities each year and (b) have material unrealized capital gains in their taxable accounts, instead donate highly appreciated shares from their taxable account. The most efficient way of doing so is to utilize a low-cost donor-advised fund.

This has the following benefits:
1) You get the exact same deduction for the gift of appreciated securities as you would if you donated cash.
2) You avoid ever having to pay taxes on the capital gains of the gifted securities. The receiving charity never has to pay them, either.
3) Using a donor-advised fund bypasses significant administrative hassle in trying to coordinate directly with multiple charities to donate securities directly to them.
4) Setting up a donor-advised fund institutionalizes what you might hope to become a family tradition. You can set up successor advisors to the fund so that your philanthropy outlives you. Kind of like your own personal charitable foundation (only with dramatically lesser costs and restrictions than an actual foundation).

Most of my clients who use donor-advised funds either use Vanguard's or Fidelity's (the last time I checked, Vanguard's has a minimum initial contribution of $25k and Fidelity's has a minimum of only $5k). If these limits are quite a bit more than your annual gifting desires, perhaps it makes sense to pre-fund the donor-advised fund with many years worth of such donations (which would allow you to take the tax deduction for multiple years worth of donations immediately :-) ). For example, someone who desires to make on order of $2.5k worth of donations annually might donate at least $5k or so to the Fidelity donor-advised fund (i.e., about two years worth) or perhaps at least $25k or so to the Vanguard fund (i.e., about ten years or so worth). Then, you would continue making the distriibutions to the ultimate recipient charities whenever the spirit moved you (i.e., at your normal rate of ~$2.5k/yr in the example). Whenever the fund balance gets low, you would consider "plussing it up" by donating some more of your most highly appreciated securities to the donor-advised fund.

This is among the "tricks" that well-informed investors do to "game" the tax system.

For more info on charitable giving and using donor-advised funds, see [link removed by admin LadyGeek]

Eric E. Haas
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chuck-lyn
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by chuck-lyn »

I recently used Vanguard's Donor Advised program to offset the taxes generated by converting 25K from my traditional
IRA to my ROTH ....keeping my overall bracket below 15%. I will likely repeat in the future pending outcome of tax law
changes.

Cheers,

charlie
Topic Author
Cash
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by Cash »

Just to add a data point for future reference: I recently opened a Fidelity charitable giving account. On 11/8, I faxed a request to Wells Fargo to make a direct transfer of certain shares to Fidelity. Those shares were withdrawn from my account on 11/9 and received by Fidelity the same day. Although the shares were noted as received on 11/9 (and for tax purposes, I think that's all that matters), it wasn't until today that they showed up in my Fidelity account balance (Veterans Day on Monday might have affected the length of the settlement period). So if you're transferring shares from Wells Fargo, I would recommend doing so at least a week in advance of the date on which you would like to donate the funds and at least a day in advance of the end of the tax year in which you would like to claim the deduction.
dickenjb
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by dickenjb »

I am planning to set up a DAF this year. In my case, I am in the AMT phase out range (Marginal rate 35%) for 2012. Next year and for the foreseeable future, will be taking the standard deduction. I plan on funding some 20+ years of charitable giving.
jhd
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Re: Tax Gain Harvesting and Donor-Advised Funds

Post by jhd »

I've done this a bit, and hope to be more strategic about it in the future.

Changes to the tax code should also factor in here: on the one hand, US tax rates will probably be higher in 2013 and beyond, so 2012 might be the wrong year to do this. But on the other hand, there is talk of new limits on charitable deductions, which could lower the amount of "TGH" one could do in a given year.
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