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Donating stock? Do the right thing

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in Small Business Tax,Small Business Tax Deduction Strategies

If you’re planning to donate stock to charity this year, there’s a “right way” and a “wrong way” to do it.

Strategy: Do it the right way. Donate low-basis stock that has appreciated in value, but continue to hold onto high-basis stock. Taking the opposite approach is the wrong way.

Due to changes in the new Tax Cuts and Jobs Act (TCJA), doing things right is even more important than before (see box below).

Here’s the whole story: Generally, if you donate stock (or other securities) to a qualified charitable organization, you can only deduct an amount equal to your “basis” in the stock (typically, your initial cost). However, if you’ve owned the stock long enough to qualify for a long-term capital gain if you had sold it instead (i.e., longer than one year), you can deduct its full fair market value (FMV) of the date of the donation.

Icing on the cake: The appreciation in the value of the stock during this holding period remains untaxed …forever!

Therefore, it often makes sense to donate low-basis stock that has appreciated substantially in value over time and keep high-basis stock, especially stock held for a year or less that would be taxed at ordinary income rates reaching as high as 37% if you sell it.

Example: Suppose you bought Alpha stock three years ago for $10,000 that is now worth $15,000. About ten months ago, you acquired Beta stock for $12,000 that is also currently worth $15,000. You intend to donate one of these two stocks to charity.

Here’s what happens from a tax perspective if you do things—

  • The wrong way: You donate the Beta stock and keep the Alpha stock. As a result, your charitable deduction is limited to $12,000 because you’ve haven’t owned the stock for more than one year.
  • The right way: You donate the Alpha stock and keep the Beta stock. Now your charitable deduction is increased to $15,000 because the donated stock qualifies for long-term capital gain treatment. What’s more, you never have to pay any tax on the stock’s $5,000 appreciation in value.

Now let’s flip the script a little. Say that stock you own has dropped in value since you acquired it. If you donate this stock, your deduction is limited to its FMV, regardless of how long you’ve held it. For instance, if you donate stock acquired for $10,000 and it’s currently worth $7,500, your deduction is limited to $7,500.

Of course, there are other tax considerations that should be kept in mind. Notably, your annual deduction for charitable gifts of property (as opposed to cash) is limited to 30% of your adjusted gross income (AGI). However, you can usually squeeze under the 30%-of-AGI bar without much difficulty.

Tip: Finally, factor nontax reasons into your decisions, including which stocks you expect to go up or down in price.

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