Charitable Capital Gain Harvesting – A Tax Twofer For Those Charitably Inclined

It is rare for the IRS to allow two benefits for the price of one, but for those considering charitable giving, here is a strategy to capture just that.  Donating appreciated securities, a method we call charitable capital gain harvesting, allows donors to receive a double benefit from charitable contributions in the form of 1) the market value tax deduction for charitable giving and 2) eliminating the capital gain liability of appreciated securities.

If you think you are unlikely to have any unrealized gains after the terrible markets we have endured, you might be wrong.  Throughout the recent market decline, we harvested tax losses for clients, converting unrealized losses into tax losses that could immediately be used to offset gains or be banked for future use.  However, this practice also lowers the basis and, as the markets recover, substantial unrealized gains accrue.  While the realized losses could be used to offset these resulting gains, there is an even better way to address them for those who are charitably inclined.  Charitable capital gain harvesting can eliminate some of these gains.

The process involves donating appreciated securities held more than one year as your charitable gift, and subsequently repurchasing the same securities with the cash you would otherwise have donated.  Aside from any charitable deduction you may receive, this strategy benefits both you and the charity. Your charity receives shares that it can immediately sell and convert to cash. You can then repurchase the securities using cash, and establish the purchase price as your new basis.

Admittedly, the concept of donating low-basis securities to charity is not new as most CPAs would likely list it as a way to get the most out of a charitable contribution.  However, what may be new is viewing it as the alter ego of tax loss harvesting, a combined strategy for managing taxes and charitable giving within your investment program.  Just as tax loss harvesting is done to intentionally realize a loss, charitable capital gain harvesting intentionally offloads the gain liability to the charity, which pays no tax on the capital gain.

The example below explains the strategy:

1. Susan desires to donate $100,000 to her charity of choice and rather than donating cash, her Evensky & Katz / Foldes advisor recommends she donate $100,000 worth of her ABC, Inc. stock that has appreciated significantly over the few years she has owned the shares. 
2. Susan contacts the charity and obtains instructions on how to transfer her securities to the organization’s gift account.
3. Her advisor instructs Susan to deposit the $100,000 of cash that would have comprised her gift into her investment account, and when received, submits the paperwork for the transfer of $100,000 of ABC, Inc. stock (with a cost basis of $40,000) to the charity. 
4. As soon as the transfer takes place, her advisor uses the $100,000 of cash to repurchase ABC, Inc. stock in Susan’s investment account preserving her market exposure and establishing her new basis in the stock of $100,000. 

The end result is that Susan’s Charity has received a donation worth $100,000 (as the charity has no tax obligation), Susan gets credit for a $100,000 donation and she still holds a $100,000 position in ABC, Inc stock; all without having to pay any taxes on what would have been a $60,000 gain had she sold the shares and then donated cash.

For charitable capital gain harvesting to be effective, one must adhere to and understand the following:

1. Securities must have been held for at least one year and donated to a qualified charity.
2. Deductibility rules for appreciated securities differ from those governing cash donations.  In order to benefit equally from a donation of appreciated securities, the donor must have a higher adjusted gross income. 
3. Unless performed simultaneously, the loss of market exposure between the time securities are donated and subsequently repurchased involves risk.  One can attempt to minimize this by repurchasing the shares as close as possible to the day that the transfer takes place.
4. The repurchased security must be held for at least one year in order to receive additional favorable long-term capital gain treatment going forward.
5. Depending on the custodian and account type, there may be transaction costs to both the donor and/or the charity.

It is also important to realize that the value of this strategy becomes greater with larger donations and securities with considerable appreciation.  In the example above and assuming a 20% long-term capital gains rate, Susan’s $100,000 donation could save her $12,000 in taxes when compared to realizing the $60,000 capital gain and paying the resulting taxes. In effect, in order to donate the same $100,000 of value to the charity, the cost to Susan is $100,000 while the cost to a donor who realizes a $60,000 capital gain is $112,000.

1 Tax loss harvesting is a method whereby securities with losses are sold in order to realize the loss with the proceeds of the sale invested in a similar but not identical security for at least 31 days (in accordance with the IRS’s wash sale rule), after which time the investor can repurchase the original securities.

2 Securities must be held at least one year in order to be “qualified appreciated stock.” If held for less than one year, the security is considered “ordinary income property” and the deduction is limited to the cost basis of the security.

3 There is a 30% of AGI limit on gifted capital gain property for 60% limit organizations such as churches, schools, hospitals, etc., and a 20% limit for non-60 % limit organizations. These limits are more restrictive than the 60% AGI limit on cash. However, unused charitable deductions can be carried forward up to 5 years.