Unfortunately, this strategy only works if you’ve held the stock for more than a year. The analysis below will be inaccurate (partially), but I believe the idea of donating stock is still a good one. This further underscores the need to discuss your decisions with a tax professional, I’m clearly a novice and making novice mistakes! 🙂
You made a few good investments this year, are about to realize those gains by selling your stock, and now you’re looking for ways to reduce your capital gains tax bill. Kudos to you for making good decisions, kudos to you for looking for a way to save some of those earnings for you and your family, and now hopefully kudos to you for taking the suggestion I’m about to dispense. Before you sell that stock, donate the funds to a charity that will accept donations of stock. This is one of the few ways you can avoid paying a capital gains bill and this is the only way, that I know of, where someone else other than you can benefit as well.
When you donate shares of stock, you get to deduct the full appreciated value of the stock from your income (as long as you itemize your deductions). So, you won’t have to pay the capital gains bill plus you get to deduct the full value of the stock from your income – a double win for you, a single win for the charity, and Uncle Sam isn’t none the wiser (he’ll be spending that money whether or not you get stuck with the bill).
Now, let’s use an example to illustrate the point. Let’s say you own a stock BFP Incorporated. At the beginning of the year you invested $2,000 and that little nest egg grew to $20,000 (yep, BFP Inc. was a ten-bagger in one year!), now you aren’t sure what to do. If you sell BFP Incorporated, you’ll owe taxes on that $18,000 in appreciation. Since you owned it for less than one year, that will be taxed at short term capital gains which is your tax rate. If that tax rate is 25%, then you’re looking at a tax bill of $4,500 on that $18,000 gain – wow! (it’s actually a little less because you can deduct the cost of buying and selling, which pales in comparison to the gains) Selling will leave you $15,500 (your original $2,000 plus the $13,500 left of appreciation after taxes).
Let’s say you instead decided to donate the $18,000, you would have a deduction of that much from your taxes which would save you $4,500 on your taxes. Take your original $2,000 and the deduction and you would end up with $6,500 in your pocket. Why would anyone consider doing this when selling would leave you with $9,000 more?
In the first scenario, Uncle Sam gets the other $4,500; in the second scenario, your charity of choice gets $13,500. In reality, there is a worse third alternative in which you sell the shares, take the tax hit, then donate the funds. The difference between scenario two (where you donate the stock) and scenario three (where you sell it first), is that in scenario three you pay the capital gains and then get it back because of the donation. In scenario two, you never pay capital gains in the first place. So, if you were going to donate to charity, donating appreciated stock is far superior to donating cash.
(Photo: Tracy O )