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Charitable property donations can have tax benefits
When was the last time you saw a stock certificate or a deed to real estate in the collection basket on Sunday?
Charitable contributions are a great way to lower your taxable income (and save taxes) while also helping out a favorite charity. But most people don’t realize there can be substantial tax benefits to donating stock or other appreciated assets held for more than a year (and thus qualified for long-term capital gain treatment), rather than selling the asset and donating the cash.
Internal Revenue Code 170(c) allows individuals to take itemized deductions for donations of money or property to qualified charitable organizations.
Imagine that Tommy Taxpayer has some capital stock with a fair market value of $10,000 for which he originally paid $3,000 (his tax basis) more than a year ago. He’s a single Michigan resident, whose income level of approximately $200,000 puts him in the 33 percent federal tax bracket (the highest federal bracket is 39.6 percent for income levels over $400,000).
If we assume an effective state income tax rate of 3 percent, his total combined tax rate (federal and state) is 36 percent. In addition, at Tommy’s income level, his combined tax rate for long-term capital gain income is approximately 21.8 percent, which is the 15 percent federal capital gains rate including the 3.8 percent net investment income tax rate and our assumed 3 percent effective state rate.
Should Tommy sell the stock and donate the cash proceeds, or just donate the stock?
Let’s start by assuming that Tommy sells the stock for its fair market value of $10,000. He will report a capital gain of $7,000 ($10,000 minus $3,000 tax basis) and pay 21.8 percent on the capital gain, or $1,526. Now, if Tommy donates the sale proceeds ($10,000) to his favorite charity and pays the tax on the gain out of his pocket, he will save approximately $3,300 in federal income tax due to the deduction of the charitable contribution ($10,000 x 33 percent).
Note that Michigan does not allow itemized deductions, so there is no tax benefit on Tommy’s Michigan income tax return.
Notice that while the charity receives a donation benefit of $10,000, the total cost of the contribution to Tommy is calculated as the value of the stock ($10,000), plus the tax paid on the sale ($1,526), less the tax savings on the contribution deduction ($3,300), or a total cost of $8,226.
On the other hand, if Tommy simply donates the stock, he is entitled to deduct the full fair market value ($10,000) as a charitable contribution. This will save Tommy $3,300 in federal income tax ($10,000 x 33 percent) for a total after-tax cost of $6,700.
Note that the charity receives a donation benefit of $10,000 in either case; $10,000 cash in the first case, and $10,000 worth of stock in the second case. The charity may sell the stock without tax since it is a charity. However, the after-tax cost to Tommy is substantially less where the stock is donated rather than sold ($6,700 versus $8,226), for a total tax savings of $1,526. Furthermore, the tax savings is even greater for taxpayers in the higher tax brackets.
This tax savings occurs because the tax rules allow a full market value contribution deduction for certain appreciated assets held more than a year such as capital stock and real property, and the capital gain inherent in such asset is never taxed. There are, however, significant limitations on how much may be deducted in any one year for appreciated assets which are classified as tangible, personal property (such as equipment or a car).
In summary, a charitable contribution of the appreciated asset itself most often gives you the most “bang for the buck.” And that means you can give more to your favorite charity.
Lara L. Kessler is an associate professor at Grand Valley State University in the School of Accounting and can be reached at firstname.lastname@example.org. Rick Harris is a full professor at Grand Valley State University in the School of Accounting and can be reached at email@example.com