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Donate stock to charity the right way

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As the end of the year fast approaches, you might make additional gifts to charity, including donations of stock or other assets. These extra donations can reduce your 2014 tax liability.

Strategy: Give away low-basis stock you’ve held for more than one year. On the other hand, absent other factors, you should keep high-basis stock.   

The reason has to do with the tricky rules for gifts of property. If you handle things the right way, you can realize tax benefits from a stock’s appreciation in value without ever paying any tax on the run-up.

Here’s the whole story: When you donate stock that would have produced a long-term capital gain had you sold it instead (i.e., you’ve owned the stock for more than one year), you can deduct the full fair market value (FMV) of the stock on the date of the contribution. Thus, the deductible amount reflects a stock’s upward climb during the recent bull market. What’s more, the appreciation in value that occurred during the time you held the stock remains untaxed—forever and ever!

However, if the stock gain would have been taxed at ordinary income rates had it been sold (i.e., you’ve owned it for one year or less), your charitable deduction is limited to your basis in the stock. You get no special tax reward for donating this stock, so you might as well keep it.

Let’s take a look at a couple of examples to illustrate these points.

Example 1: You acquired stock three years ago for $4,000 with a current FMV of $10,000. If you donate the stock to charity, you can deduct the full $10,000. There’s no tax due on the $6,000 of appreciation in value.

Example 2: You acquired stock nine months ago for $2,000 with a current FMV of $5,000. If you donate the stock to charity, your deduction is limited to $2,000. Because you receive no tax benefit from the $3,000 appreciation in value, you might hold onto the stock. Alternatively, you can sell the stock and donate the proceeds. In that case, you can deduct the full $5,000, but you’ll have a $3,000 short-term gain.

All things being equal, if you have a choice between donating low-basis stock held more than one year and high-basis stock, the better choice is usually the low-basis stock. Of course, existing capital gains and losses and other factors may affect your situation.

Suppose you own stock that has depreciated in value. If you can use a tax loss at the end of the year, you can sell the stock and turn around and donate the sales proceeds to charity. Other­­wise, if you simply donate the stock, your deduction is limited to its FMV.  

Of course, there are other possible reasons for selling or holding a particular stock. For instance, if you hold low-basis, long-term stock that you think is about to take off, you may want to hold onto it for the time being.

Tip: Conversely, if you own stock that you think has peaked, you might donate it now.

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