The right time for investors to rebalance—and give to charity

By Tony Oommen, CFP®

Jenga tower on hardwood floor

Ten years into a bull market and with stocks at record highs, now is an opportune time for investors to rebalance their portfolios. As bull markets mature, portfolios may become over-weighted with equities, increasing an investor’s vulnerability to stock market corrections. For example, a portfolio comprised of 60% equities and 40% fixed income at the start of the current bull market in 2009, could easily now have 80% of its overall value represented by equities because of appreciated stock values. The S&P 500 has gained more than 350% since the bottom of the market in 2009—talk about a gains ripe for a charitable harvest!

With the December 31 tax deadline just around the corner, now might be the right time to put that strategy in motion by rebalancing, charitably.

Reducing exposure to stocks in a taxable investment account typically means selling appreciated positions, which generally triggers a capital gains tax liability. That’s where charitable giving can help: donating to charity can be a great way to support the causes you care about, while potentially offsetting tax liabilities accrued by the portion sold through rebalancing or portfolio diversification. 

Investors need to proceed in a tax-smart way. Cash is not always king—appreciated assets can be. Yet, surprisingly, close to 90% of high-net-worth households who make charitable donations do so with cash.1 Cash is often the most expensive asset to give to charity because in most cases, the donor will have incurred taxable income to free up cash to give. Cash donations miss an opportunity to give up to 23.8% more to charity without any additional cost to the donor.

Here’s how to do it: instead of selling long-term appreciated assets (owned for more than 12 months), and donating the proceeds to charity, investors can donate the assets directly to charity. That gives them a double benefit: they are generally eligible to claim a charitable deduction for the full fair market value (FMV) of the asset and can potentially eliminate up to the 23.8% capital gains tax they would have otherwise incurred on the sale.2

Consider the tax difference in making a charitable donation of $50,000 in stock with $30,000 of unrealized capital gains, as opposed to selling the stock first and then donating the cash proceeds.

If an investor sells the stock, they’d have to pay about $7,140 in tax on the $30,000 gain (based on the 20% capital gains tax and 3.8% Medicare surcharge). That leaves $42,860 to give to charity. While saving $15,858 in income tax thanks to the charitable deduction of $42,860, the ultimate tax benefit to the investor is just $8,718 after subtracting the capital gains tax paid.3

Now consider the simpler approach of donating the $50,000 in stock. In that case, there’s no capital gains tax. Instead there’s a charitable deduction for the full $50,000 FMV of the stock and a potential tax savings of $18,500—more than twice as much as with the cash gift. Importantly, the full $50,000, undiminished by capital gains taxes, would be available for charitable purposes.

Not All Gifts Offer Same Tax Savings

The best investments to donate are usually those with the most unrealized long-term capital gains—concentrated positions with low cost basis. Donations can be made using a wide range of asset classes, from common stock to bitcoin to non-publicly traded assets such as private stock. With private stock, an investor could be facing a huge capital gains tax bill because these assets generally have very low or even zero cost basis. Using a charitable donation to partly offset that tax bill is a great strategy for philanthropically inclined.

Cost basis comparison chart

A smarter way to give?

Giving away a slice of a portfolio doesn’t have to be complicated. An increasingly popular method is to donate appreciated securities to a public charity with a donor-advised fund (DAF) program. DAFs let investors contribute now for an immediate tax deduction, recommend how the contribution should be invested to potentially grow tax-free, and then advise which charities should receive grants. For charitably minded investors who want to make a difference, the simple choice of donating appreciated securities, rather than cash, can allow them to make MORE of a difference.

And with the December 31 tax deadline just around the corner, now might be the right time to put that strategy in motion by rebalancing, charitably.

1 “2016 U.S. Trust Study of High Net Worth Philanthropy,” conducted in partnership with the Indiana University Lilly Family School of Philanthropy. The majority (86.6 percent) indicated that they gave through a cash or check donation, with nearly half of high net worth households choosing to donate online, or with a credit card through other methods (in person, by mail, or by phone).

2This assumes all realized gains are subject to the maximum federal long-term capital gains tax rate of 20% and the Medicare surtax of 3.8%, and that the donor originally planned to sell the stock and contribute the net proceeds (less the capital gains tax and Medicare surtax) to charity. Does not include state taxes, so additional tax savings on top of federal are possible, depending on the donor’s state of residence.

3This example assumes a married couple, filing jointly in the 39.6% federal income tax bracket, and a fully deductible donation at fair market value to a qualified public charity. It does not take into account state or local taxes, the alternative minimum tax, or limitations on deductions for taxpayers in higher income brackets. The charitable deduction is only available at the federal level if you itemize deductions. Charitable contributions of capital gains property held for more than one year are usually deductible at fair market value. Deductions for capital gains property held for one year or less are usually limited to cost basis. This is a hypothetical example for illustrative purposes only. Results will vary, depending on an individual’s tax situation.

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