Andy Warhol,9 Dollar Bills, 1982
With the stock market at record highs, many people have substantial long-term capital gains in their investment portfolios. When it comes to being generous with charities or family members, using appreciated securities is sometimes wiser than using cash. Let’s consider two important cases.
Charitable Giving
Suppose you want to make a $5,000 contribution to a charitable organization. You write a check and get a $5,000 charitable deduction. Assuming you are a NYC resident in the 33 percent federal tax bracket (making approximately $200,000 to $400,000) who itemizes deductions, you save approximately $2,200 in federal, state, and local income taxes.
Instead, suppose you have appreciated securities in your portfolio that you would like to sell, perhaps to lower your equity exposure or simply rebalance your portfolio. When the securities are sold, you will need to pay capital gains tax on the appreciated value. If you are in the 15% capital gains tax bracket and live in NYC, you will pay approximately $.25 for every dollar of appreciation. If the securities you are considering selling have doubled in value (which is not unusual in the eighth year of a bull market), then selling $5,000 of appreciated securities will create $2,500 in capital gains and a capital gains tax of approximately $625.
However, if the $5,000 in appreciated stock is donated to the charity, then you still get the $5,000 deduction and the associated income tax savings, but also save $625 in capital gains taxes. For these reasons, appreciated securities are often a better way to make charitable donations.
Gifting appreciated securities to your children or grandchildren
Suppose you want to gift your daughter $14,000 per year as part of your estate plan. Under current law, you can gift $14,000 a year per individual and maintain your estate tax exemption amount.
If you gift $14,000 of appreciated securities, you will not have to pay capital gains taxes nor gift taxes. You have just gotten $14,000 out of your estate without incurring any taxes. However, your daughter receives the securities at your original cost basis. When she sells the securities, she will have to pay the capital gains taxes. So effectively, the capital gains taxes were transferred from you to your daughter, who still comes out ahead because she received a gift, but the gift is potentially worth less than $14,000 when she nets out the capital gains taxes. Since the tax is not avoided, why do this at all?
The answer depends on your child’s tax bracket. If your child just graduated from college and will work full time for only part of the year, then it is likely that her capital gains tax will be zero if she sells the security during that year. As long as your child’s capital gains tax bracket is lower than yours, your family will save on capital gains taxes even if you don’t avoid them altogether. For this strategy to work, your child must sell the securities while her income is low. If she holds on to the securities and sells them after her income has increased as she matures in her career, then the strategy won’t work.
Dalya Inhaber, Ph.D., CFP ® is a financial advisor based in New York. She is the founder of Minerva Wealth Advisory, a Registered Investment Advisory firm. The mission of the company is to provide clients with tailored and unbiased financial planning and investment management. Dalya holds a Ph.D. in economics and statistics from the University of Michigan. The firm is named after Minerva - the Roman goddess of wisdom and knowledge. Minerva is often depicted with her sacred creature the owl, whose keen eyesight helps her navigate a path forward.