Investors focused on capital gains and what to do about them until 2021. You can reduce taxes and maximize after-tax income by cashing in the gains using a strategy of charitable donations.
The strong appreciation of the stock market over the past two years has allowed many people to sit on substantial investment gains. Some seek to take a portion of those profits while others wish to rebalance their portfolios, reducing stocks to a lower percentage of their portfolios.
Investors are also worried about the possibility of an increase in long-term capital gains taxes in 2022 or later years. Higher taxes on capital gains, at least for those with higher incomes, were among the tax increases proposed this year.
Of course, an investor could sell some of the investments. But for assets held in taxable accounts that would result in capital gains taxes on profits. People in the highest tax brackets, especially those in their 60s or older, could trigger some of the stealth taxes, such as taxes on Social Security benefits, the surtax on health insurance premiums and 3.8% tax on net investment income.
An alternative is to donate stocks or mutual funds to charity.
When you itemize the expenses on Schedule A of your income tax return, you get a charitable donation deduction equal to the fair market value of the asset on the date of transfer to a charity. You do not owe any tax on any capital appreciation that occurred while you owned the investment.
If you haven’t identified which charities you want to give or don’t want to give a large amount all at once, you can transfer the investment to a Donor Advised Fund (DAF) account. This allows you to take advantage of the tax deduction in 2021 but wait until later to distribute money to individual charities.
Meanwhile, the DAF account is invested so that the value can increase. Unlike an IRA, you don’t have to put money into a DAF. You can transfer the investment so that it continues to appreciate without interruption.
Many CFOs now accept contributions from a wide range of assets, including cryptocurrencies. A spokesperson for the Schwab Charitable Fund recently said The Wall Street Journal that the fund accepted land, grain, racing cars, quarter horses, and participation in a National Football League team.
Another strategy is to donate the assets to a charitable residual trust (CRT).
You create the CRT and transfer the assets to it. The CRT generally sells the assets and reinvests the proceeds in a more balanced portfolio. The CRT incurs no capital gains tax when assets are sold, since the CRT is a non-taxable charitable fund.
The CRT makes distributions to you for the rest of your life or for a period of several years, depending on what you determine when the CRT was created. At the end of the distribution period, the assets remaining in the trust are donated to the charities you designate.
When you transfer assets to CRT, you are entitled to a charitable contribution deduction equal to the present value of what the charity is estimated to receive in the future. You must itemize the expenses on your income tax return to benefit from the deduction.
CRT is known as a triple tax advantage strategy. You benefit from a tax deduction the year of your transfer of assets to the CRT. You do not owe any capital gains taxes on the appreciation that occurred while you owned the property. The trust also owes no capital gains tax when it sells the property. In addition, the value of the CRT will not be subject to your federal property taxes.
A variation of the strategy is to transfer the investments to a charity in exchange for a charitable annuity. You owe no capital gains tax on appreciation. The charity pays you an annuity for the rest of your life.
Annuity payments will be lower than what you would receive from a commercial annuity. The difference is a gift to charity. You are entitled to a charitable donation deduction in the year you transfer assets to the charity.
These are just a few charitable giving strategies for those with long term capital gains. When you are inclined to charity and have some capital gains that you would like to cash in, consider using a charitable giving strategy. Many people find that they maximize their after-tax income by integrating charitable giving into investment and tax strategies.