Instead of donating cash to charity, you might want to give away stock. Just remember to do things the right way.
Strategy: Donate stock with a low basis and keep your stock with a high basis. Even though you can generally deduct the full fair market value of the donated stock, you don't have to pay any tax on its appreciation in value ... ever!
Here's the story: If you donate stock that would have produced a long-term gain if sold (i.e., stock held more than one year), you can deduct the stock's fair market value at the time of the contribution.
But if a stock sale would have produced ordinary income (i.e., stock held one year or less), your deduction is limited to your basis in the stock. For stock that has declined in value, your deduction is limited to its fair market value.
In other words, if you donate low-basis stock that you've held more than a year, you earn a tax benefit from the stock's appreciation. Similarly, you should not donate low-basis stock that you've held for less than a year or high-basis stock that is now worth less than you paid for it.
Example: Let's say you bought Retail Corp. stock for $1,000 two years ago and Electronic Corp. Inc. stock for $2,000 about 10 months ago. Now, the Retail stock is worth $3,000 and the Electronic stock is worth $4,000. Which stock should you donate to charity?
The wrong way: If you donate the Electronic stock (held for less than a year), your charitable deduction is limited to your $2,000 basis, because the stock is treated as ordinary income property.
The right way: Donate the Retail Corp. stock, instead. Your charitable deduction rises to $3,000 because the donated stock (held more than a year) is long-term capital gain property. You don't owe any tax on the stock's $2,000 appreciation.
Of course, you may have other valid reasons for keeping certain stock and donating others. For instance, you may want to hold on to a stock that has declined in value if you expect it to rebound. Just remember to factor taxes into the equation.
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