Could donating stock save you $100k?
Donating appreciated stock instead of cash is a well-known tactic within the personal finance community. Yet, I’m always surprised by how few people seem to utilize this strategy.
A Blackrock analysis of high-income taxpayers found that 75% donate cash to charity, while <10% donate securities. Fidelity Charitable surveyed wealthy households giving sizable sums to charity and found that 59% were aware of this strategy but only 19% used it.
I’ll show in this post how charitably minded Christians could generate as much as $100,000 in tax savings by deploying this giving strategy over the course of a lifetime.
A quick review of the basics
When you sell a security – like a stock, ETF, or mutual fund – you typically pay tax on the gains that you earned. The gain is the difference between your original purchase price and your ultimate sale price. The price you originally paid is referred to as your “basis” in the asset.
Simple example: You buy a stock for $100 (this is your basis). It does great and 5 years later it is worth $300. If you sell at that time, you will owe tax on your $200 gain.
If you have owned the asset for more than 1 year, then the gains are subject to long-term capital gains treatment. This is generally favorable, as capital gains tax rates are usually less than ordinary income tax rates (i.e. how W2 wages are taxed). Like ordinary income brackets, capital gains taxes are progressive, meaning the rate increases with your earnings.
After factoring in the net investment income tax you get the following effective federal tax brackets:
Conceptually, ordinary income fills in first, with your capital gains “stacking” on top of that.
Example: You are married filing jointly (MFJ) and make $220k of taxable income from your W2 earnings. The last of these dollars is taxed in the 24% ordinary income bracket. If you have $10k of long-term capital gains, this counts as dollars $220k-230k, subject to a 15% tax per the far-right column.
As always, state taxes are in addition to what the federal government takes. Most states tax capital gains and ordinary income at the same rate.
How donating stock saves you money
Donating stock to charity can create tax savings due to 2 fundamental principles:
If you sell the stock, you will owe tax on the gains (per above).
If you give the stock to charity, they can sell it and won’t owe the IRS a penny.
Poof. The tax liability disappears.
Let’s bring this to life via an example: You intend to give $10,000 to your church this year. You also plan to sell $10,000 of stock to help fund a down payment on a new house.
Scenario #1: Donate cash
You donate $10,000 to your church via ACH transfer from your checking account. The church owes no tax and has $10,000 to spend on its ministry.
You sell $10,000 of stock that you purchased 10 years ago for $4,000. Your effective capital gains tax rate is 18.8% (applied to the $6,000 gain), so you owe $1,128 in tax.
After paying your tax bill on the sale, you are left with $8,872 to use for your down payment.
Giving appreciated stocks beats cash on tax efficiency.
Scenario #2: Donate stock
You donate the $10,000 of stock to the church. The church receives the stock and immediately sells it. As in the base case, they owe no tax and have $10,000 to use for ministry.
Instead of using your $10,000 cash reserves for church donations, you now use these funds for your down payment. By avoiding the $1,128 capital gains tax from the base scenario, you have more money to use (and the IRS gets less).
Note: This strategy works regardless of if you itemize or take the standard deduction. If you itemize, the savings from this strategy are in addition to the benefit you receive from itemizing (as the IRS allows you to deduct the market value of your stock donation, up to 30% of your AGI). I.e. Both scenarios above would result in a $10,000 deduction on your tax return.
Playing the long game
Okay, but what if – unlike above – you are in saving/investment mode and don’t plan to sell any stock this year? Assuming you plan to use the stock someday in the future, this strategy can still be valuable.
Scenario #3: Donate stock & simultaneously repurchase
Like scenario #2, you donate the $10,000 of stock to your church. On the same day, you purchase $10,000 of new stock using funds from your cash reserves.
Your investment exposure is unchanged – as you simultaneously donated (outflow) and purchased (inflow) the same amount of shares of the same security at the same market price.
But what is changed is your cost basis. You now own $10,000 worth of stock that you purchased for $10,000 (i.e. your cost basis is now $6,000 higher). Thus, when you sell this stock holding in the future, your gain will be $6,000 lower than it would have otherwise been.
If you are still in the 18.8% LTCG tax bracket at the time of sale, you’ll avoid $1,128 of taxes (same as scenario #2 – but you defer the tax savings until the future date of the sale).
And this can be done year after year. The optimal strategy involves continually donating your shares that have the highest gains and simultaneously repurchasing new securities (and thus resetting your basis at today’s higher prices).
Sizing the prize
So far so good, but how much value can this strategy generate if deployed consistently? Is it worth the effort?
Scenario #4: Mr. Consistent
Let’s imagine that you plan to give $20k to charity and invest $30k in stocks via your taxable brokerage account. Each year you increase both by inflation and you execute the discussed strategy consistently for 30 years before selling.
First, your consistency will bear significant fruit for both charity and your personal balance sheet. In present value terms, you will donate $600k to charity and end with $2.1m in assets (before paying your LTCG tax).
By donating stock and replenishing each year, you will have raised your cost basis – and therefore reduced your gain – by $483k! This will save ~$91k in taxes at the time of the sale, which is the equivalent of ~$44k if we discount back to today’s dollars.
Said a different way, $44k is a 7.4% tax rebate on the present value of your total donations and is the equivalent of 2.2 “years of donations” (=$44k / $20k)! That’s a lot of free money just for being savvy in how you make your donations.
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If stocks return a geometric mean of 8.0%, the two largest determinants of your tax savings are A) how long you use the strategy prior to selling, and B) your marginal tax rate when liquidating. If we think about the magnitude of the tax arbitrage in terms of “years of donations”, we can show a more generalizable output.
If you execute the strategy for 20 years and are in the 15% LTCG tax bracket at the time of sale, you generate tax savings equal to 1.0x your annual giving amount. The multiplier increases with time and your marginal tax rate. It could be as high as 3-4x (anything more than that is unlikely in practice).
For a high earning, generous household donating over $30k per year, this strategy could ultimately be worth over $100k in present value tax savings!
Note: The top LTCG tax rate in CA is 13.1%. When added to the max federal bracket of 23.8% this yields an (astonishing) total of 37.1%. This rate is included in the table to show the extreme upper bound.
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If you haven’t been donating stocks your entire working life – don’t fret. Most of the benefit is back loaded.
Scenario #5: The Late Bloomer
Let’s modify scenario #4: As before, you invest $30k annually in real terms for 30 years. But you didn’t learn about the value of donating stock until year 16. Despite only executing the strategy for the last 50% of years, you will still capture 85% of the total potential benefit (~$38k vs ~$44k).
(Note: Unfortunately, the same is not the case if you were late to realizing the importance of investing early. You’ll have to save a lot more aggressively if you have less time to enjoy the benefits of compounding.)
Conclusion
Some final thoughts to consider as you contemplate this approach:
This strategy is only valuable if you think you’ll ultimately sell your stock holdings and incur LTCG tax. If you are in the 0% bracket, this will have no value. If you bequeath your assets, your heirs get a step up in basis anyway, so this strategy is not accretive.
No one knows the future for certain. Even if you think this won’t apply due to #1 above, it might still be worthwhile in case life unfolds differently than you expect today. Donating stock is certainly not worse than donating cash!
Using a donor advised fund (DAF) can make donating securities logistically much easier for you as the donor and remove the difficulty entirely for the receiving charity. More on this in future posts.
This can also be a tax-free way to rebalance or make other adjustments to your portfolio without having to realize any capital gains. For example, you could donate stock and simultaneously purchase bonds to shift your asset allocation.
Depending on your situation, other methods of giving may be even more tax-advantaged (e.g. making a qualified charitable distribution).
This strategy relies on having appreciated assets in your taxable account. It’s usually more advantageous to invest in other account types first (e.g. 401(k), backdoor Roth IRA, etc.) Only households with surplus to invest in taxable accounts will find this strategy beneficial.
Resetting your cost basis at today’s prices allows you to tax loss harvest if the market declines. This opportunity may not have been available to you if you had held onto the original shares with low basis.
This strategy can be combined with other maneuvers to generate even more tax savings (e.g. itemizing deductions, bunching donations utilizing a DAF, etc.)
I suspect many donors are leaving significant money on the table by donating cash instead of appreciated securities. It’s clearly worth considering if this makes sense for you!
Postscript
My model simplifies the world by assuming an 8% annual return on stocks with no dividend yield (i.e. the entire gain comes through price appreciation). This is obviously an abstraction – the current yield on VTSAX is 1.35%. But my goal here was to quantify within a reasonable range the total size of the prize from continually executing this strategy.
In scenarios 4 and 5 the donor saves and gives the same real amount every year. In reality, most people probably start with smaller amounts early in their career and increase donations and savings at a faster rate than inflation. The model generates similar outcomes for this type of scenario. I opted for the “constant real” approach to make things easier to understand.
Credit to Michael Kitces for the helpful visual on tax brackets. I leveraged his format but updated the numbers here for 2024.