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The Right Time for Investors to Rebalance—and Give to Charity

By Tony Oommen, CFP®

Jenga tower on hardwood floor

What do a Dow above 23,000, the prospect of tax reform, and donating to help hurricane victims have in common?

These are all excellent reasons for charitably inclined investors to consider a charitable rebalance—rebalancing an investment portfolio with giving to charity in mind.

Eight 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 75% of its overall value represented by equities because of appreciated stock values. The level of the S&P 500 has more than tripled since the bottom of the market in 2009.

If tax reform leads to fewer or lower deductions, charitable rebalancing would be a particularly important strategy to consider in 2017.

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 minimizing a prospective tax hit.

The impact of possible future tax reform on charitable deductions is unclear. If tax reform leads to fewer or lower deductions and/or doubling the standard deduction, charitable rebalancing would be a particularly important strategy to consider in 2017. For a taxpayer currently itemizing their deductions, taking a larger standard deduction may become more attractive, eliminating the ability to claim the charitable deduction and all the associated benefits, like charitable rebalancing. This uncertainty, combined with today’s bull market make it an excellent time to consider the tax advantages of charitable donations before year-end.

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 $16,973 in income tax thanks to the charitable deduction of $42,860, the ultimate tax benefit to the investor is just $9,833 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 $19,800—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.

The best investments to donate are usually those with the most unrealized long-term capital gains. 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, private equity investors or business owners who are considering taking advantage of a healthy M&A environment and selling.

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. In the past few weeks, for instance, a number of Fidelity Charitable® donors have been able to easily recommend grants to hurricane relief efforts because their DAFs served as a ready reserve for charitable support—an excellent outcome of this strategy.

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.

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.

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.

Share these tax-smart charitable giving strategies to help your clients meet their philanthropic goals.

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