As part of optimizing your portfolio for taxes, you should assess how much of your invested money you can donate to reduce capital gains tax, instead of donating cash.
When people consider donating money to charity, they have plenty of motivations for doing so. Generally, they want to have a positive impact on a cause they care about. They may also desire to decrease their tax liability by claiming more deductions on their tax return.
When you’re an investor, there’s yet another reason to give to charity, which is to avoid capital gains tax.
When an investor transfers assets (that have increased in value) to a tax-exempt charitable organization—like a religious organization, university, or a homeless shelter—the full value of the asset is transferred to the charity. You, the donor, don’t pay taxes on the gain, and the recipient organization generally doesn’t pay taxes on the gain either (certain private foundations may be subject to a 2% excise on investment income). It’s the federal government’s way of recognizing that donations have a net positive effect for society even though the IRS gives up potential tax revenues.
When you avoid capital gains and claim a deduction, your charitable giving becomes an effective way of optimizing your portfolio for taxes. At Betterment, we calculate an investor’s giftable amount to both avoid capital gains tax and claim a deduction.
This method of charitable giving is what many wealthy donors have been using for years to reduce their tax liability. However, many smaller investors haven’t had a financial advisor looking out for their best interest and they haven’t been able to take advantage of using charitable giving to optimize for taxes.
How to Figure Out How Much to Give
The calculation for figuring out how much of your invested account you can give is just a two-step process, but as you’ll see, the devil is in the details.
- The federal government’s rules say that you can deduct the current market value of appreciated assets you’ve held for greater than a year. This tax deduction for itemizers is also allowed against AMT (Alternative Minimum Tax). This means you have to identify which specific shares you’ve held for more than one year. If you’re an investor who only deposits once or twice a year with individual stocks and bonds or ETFs, that may not seem too difficult. But if you’re dealing with many contributions each year with many different securities, it can a bit of a complicated task. Put it this way, you’ll need a spreadsheet.
- Identify which of those assets have appreciated over time. The assets best suited for donation instead of cash contributions are those that have the greatest amount of appreciation. To identify these assets, you’ll need to find the current price of each asset that you’ve held for more than year and identifying that your purchase price was lower. As with the first step, if you have many assets within your portfolio (as Betterment customers do), this can be a very complicated process.
The total dollar value of the securities at Betterment you’re eligible to donate is the current value of all appreciated assets that you’ve held for more than a year. It’s worth noting that this value can and will fluctuate, so it’s important to calculate this number as you’re ready to make the donation.
How Betterment Automates Calculating a "Giftable" Amount
Because keeping track of your holdings is, indeed, a lot of work, part of the value of investing and optimizing your portfolio using Betterment is that you can donate your investments much more easily to reap the tax benefits. When you’re looking to give from one of your accounts, Betterment automatically reports the amount eligible for donation based on the steps above. We assess which shares of your investments have been held for more than one year, and of those, which shares have the most appreciation.
The value of those shares are reported back to you in dollars, so that you can determine how much of your capital gains you wish to gift away tax-free. Because it’s automated, if you aren’t quite ready to make your donation, all that math and asset tracking is done again and again any time you move to start a charitable gift.
Many of the United States’ most prolific philanthropists have saved on huge sums of capital gains taxes by gifting securities to charity rather than donating cash. It’s an important part of how America supports its charitable causes—giving donors secondary and tertiary motivations for giving more. By helping everyday Americans use the same exact tax-saving method of gifting securities rather than cash, Betterment hopes to democratize the benefits of tax-advantaged charitable giving.
Betterment’s not a tax advisor, so as you make your charitable donations and look at how to properly claim deductions on your tax return, it’s best to consult a tax professional. Check out the full explanation of Betterment’s charitable giving feature.