If you want to make a large donation to your favorite charity, you don’t necessarily have to give cash. Instead, you might donate shares of stock in your portfolio.
Strategy: All other things being equal, give away stock with a low tax basis. Conversely, you should generally hold onto stock with a high basis.
As a result, you may be able to deduct the full fair market value of stock contributed to charity. If you take this approach, you don’t have to pay any capital gains tax on the stock’s appreciation in value all these years.
Here’s the whole story: If you donate stock that would have produced a long-term gain had you sold it (i.e., you’ve held the stock more than one year), the tax law says 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, your deduction is limited to your basis in the stock. Conversely, if the stock has declined in value, your deduction is limited to the fair market value of the stock.
In other words, if you donate low-basis stock that you’ve held more than a year, you realize a sizable tax benefit from avoiding capital gains tax on the appreciation in value. On the other hand, you should keep low-basis stock you’ve held for less than a year or high-basis stock that is now worth less than you paid for it. There’s no extra tax benefit for donating this stock.
Two wrongs don’t make a right
Let’s say you bought ABC stock for $1,000 two years ago and XYZ stock for $2,000 about six months ago. Now the ABC stock is worth $3,000 and the XYZ stock is worth $4,000. From a tax perspective, here’s what happens if you do things the wrong way or the right way:
• The wrong way. You donate the XYZ stock and keep the ABC stock. In this case, your charitable deduction is limited to your $2,000 basis because you have not met the long-term holding period requirement.
• The right way. You donate the ABC stock and keep the XYZ stock. As a result, your charitable deduction increases to $3,000 because the donated stock is long-term capital gain property. What’s more, you don’t owe any capital gains tax on the stock’s $2,000 appreciation in value.
Of course, you may have other valid reasons for keeping certain shares of 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.
Tip: For 2012, the maximum tax rate on most dividends is only 15%. If you own stocks that pay high dividends, you might hold onto those stocks and donate stocks that pay little or no dividends.
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