Appreciated Securities

Making Gifts of Appreciated Securities

At A Glance

Gifts of long-term appreciated securities (assets held for more than one year) are the most popular type of non-cash gift. The securities are often publicly traded stocks, but may include bonds, mutual fund shares and closely held stock. The securities can be given outright or used to fund a split interest charitable gift such as a charitable gift annuity or a charitable remainder trust. Because of the tax benefits, donors may be able to make these outright gifts in a more cost-efficient manner than they otherwise would by making cash gifts.

In selecting the most appropriate asset to give, donors often choose a stock that has appreciated greatly in value and/or one that the donor can part with in order to adjust his or her investment portfolio. Completing a gift of securities is for the most part, relatively easy to do—particularly if the stock is listed on one of the major exchanges or actively traded over the counter. Valuing securities without regularly available price quotes such as closely held stock require more careful attention.

Tax Benefits of Long-Term Appreciated Securities

There are definite tax advantages in giving appreciated securities when these securities were acquired more than one year earlier. In most cases, the fair market value of the stocks, bonds and mutual fund shares will be allowable as a charitable deduction. For example, if the donor gives stock now worth $10,000, the donor can usually deduct this full amount even though he or she may have bought the stock for substantially less.

In addition to being able to deduct the full amount of the fair market value of securities, a donor avoids capital gains tax and high-income taxpayers also avoid the investment income tax. This is another important tax reward provided by Congress to encourage gifts of appreciated securities. No matter how much the stocks, bonds and mutual fund shares have appreciated in value, a charitable gift will not make any part of the appreciation taxable. This means a donor realizes a charitable deduction even on the gains that have never been taxed. In essence, the donor gets what amounts to a double tax benefit: the charitable deduction plus capital gains tax avoidance.

Stock Gifts vs. Cash Gifts

One of the best ways to understand the value of a gift of long-term appreciated securities—and to convey this idea to a prospective donor—is to compare the tax benefits of a cash gift with a gift of stock, one that has enjoyed considerable appreciation. Let’s look at an example.

Example—Dr. Jones, one of your long-time supporters, intends to give your organization $5,000. He could write a check for $5,000 or give you appreciated stock worth $5,000 that he has been thinking about selling. Either way, assuming he itemizes his deductions, he will be able to deduct $5,000 as a charitable contribution on his federal income tax return.

What is the big advantage of giving securities rather than cash? Dr. Jones also avoids capital gains tax. If he sells the stock, purchased years ago for $1,000, he will have to pay a capital gains tax of approximately $800 (a gain of $4,000 taxed at 20%). And consider the net investment income tax of 3.8% which is due on capital gains for taxpayers with MAGI above $200,000 ($250,000 for a joint filer). That would be an additional $152 in tax due on the sale of the securities. Thus, the real after-tax value of the stock to Dr. Jones is only $4,048.

But there is no capital gains tax incurred when he gives long-term appreciated securities (held for more than one year) to a qualified charitable organization. And because the charitable deduction will reduce his federal income tax by $1,850 (in his 37% tax bracket), the after-tax cost of his generous gift—after taking the $800, $152 and $1,850 tax savings into account—will be only $2,198.

 

Cash Gift

Stock Gift

Gift Amount

$ 5,000

$ 5,000

Charitable Tax Savings*

$ 1,850

$ 1,850

Capital Gain Tax Savings

N/A

$ 952

Net Cost of Gift**

$3,150

$2,198

* Note: Tax bracket x value of gift = charitable tax savings (available if the donor itemizes)

** This example does not show the additional savings that may have resulted from avoiding (1) state capital gains taxes and (2) the transaction costs of selling the securities.

Limitation on Tax Deduction

The deduction allowable for a gift of long-term appreciated securities cannot exceed 30% of adjusted gross income in contrast to the 60% ceiling for gifts of cash, with a five-year carryover of any excess deduction, subject to the percentage limitations in the carryover years. However, there is a special election available to the donor: If the donor chooses to reduce the amount of the claimed contribution from the stock's fair market value to the donor's tax basis, the donor can elect to deduct a gift of long-term appreciated securities under the 60% ceiling.

This might be advisable from a tax point of view when the amount of appreciation is small and the donor is enjoying a high-income year. But keep in mind that the election must apply to all appreciated property donated during that tax year, and once made the election cannot be revoked on an amended return. See section on charitable income tax rules.

Charitable deductions for contributions of long-term appreciated securities to most private foundations cannot exceed 20% of the donor’s adjusted gross income. For gifts of short-term appreciated securities to most private foundations, the limitation is 30% of the donor’s adjusted gross income. (Both deductions are limited to the securities’ cost basis.)

Qualified Appreciated Stock

Generally speaking, a donor who makes a gift of securities to a grant-making private foundation must reduce the contribution amount by the amount that would have been long-term capital gain. However, the donor who makes a gift of "qualified appreciated stock" to such a private foundation can deduct the full fair market value. Qualified appreciated stock is stock that:

image\bullet.jpg Is traded on an established securities market, and

image\bullet.jpg Would have resulted in long-term capital gain if sold on the date of contribution.

Short-Term Appreciated Securities

Securities that have been held for one year or less are considered short-term for tax purposes. The charitable deduction for such gifts is limited to cost basis. Unless the cost basis is close to fair market value, the donor will find it more taxwise to make charitable gifts with securities held long-term (more than one year).

Limitations on charitable deductions of appreciated securities

         
 

Long-term appreciated securities to 50% organizations

Long-term appreciated securities to private foundations*

Short-term appreciated securities to 50% organizations

Short-term appreciated securities to private foundations*

Percentage limitation


30%


20%


60%


30%

Amount deductible

Fair Market Value

Cost basis**

Cost basis

Cost basis

*The following private foundations are not included in this category: pass through foundations, private operating foundations and pooled fund foundations.

**This does not apply to gifts of qualified appreciated stock.

Strategic Considerations

Reacquisition of Donated Stock

Sometimes a potential donor is reluctant to make a charitable gift of stock because of its future potential growth. Planning Tip: Suggest that the donor make the charitable stock gift to get the double tax benefit; then buy the same number of shares on the open market which brings the donor's equity position back to where it was before. When the donor sells these shares later, his or her capital gains tax liability will be reduced because of the higher cost basis as compared to a sale of the original shares.

Depreciated Securities

We're all aware that securities can go down as well as up. Depreciated securities are not good candidates for charitable gifts. A better strategy is to have the donor make the charitable gift with long-term appreciated securities. Should a donor wish to use them for gifting purposes (for example, to get rid of an unpopular stock), the best procedure is to have the donor sell the stock, give the proceeds to charity, and take the loss on his or her tax return. If a donor gives "loss" stock to charity the donor does not reap the tax benefits of the deductible loss.

Valuation of Securities

While there are tax advantages with gifts of securities, they cannot be made as effortlessly as gifts of cash. This is due in large part to the rules pertaining to valuation for tax purposes.

Most securities traded on the major stock exchanges or over the counter are relatively easy to value using market quotations. However, some that are traded less or unlisted may require more attention and attribution (possibly an appraisal); and, others such as closely held stock or restricted stock require the services of a professional appraiser.

Split Interest Charitable Gifts Funded with Appreciated Securities

Split interest charitable gifts may be funded with appreciated securities. Donors are attracted to this arrangement because it may reduce their concerns about the volatility of the stock market. For example, a donor fearing a decline in an appreciated security's value may fund a charitable gift annuity with securities. The annuity will pay the donor a fixed income for life based on the stock's value at the time of the gift. In addition, the donor will receive an immediate charitable income tax deduction.

Types of Securities

Publicly Traded Stock

The valuation of a gift of a publicly traded stock is simply the mean average of the high and low selling prices of that stock on the date of the gift.

Most of the relevant figures can be found in the Wall Street Journal or a financial news website. You also can check with a broker to confirm your figures or to find the figures for unlisted or hard-to-find securities. Note, too, that stocks can be valued only on regular business days - not weekends or holidays.If a gift of stock is completed on a weekend or a holiday, the donor you would use the weighted average of the means between the highest and lowest sales on the nearest dates before and after the valuation date.

Another point needs special emphasis. Since a charity has the option to retain or sell securities after the gift, the net proceeds may be quite different from their value on the date of the gift (the valuation date). Thus, the subsequent sales price or current valuation (if charity retains stock) is irrelevant for valuing the stock and determining the charitable deduction. Only one factor is relevant: the average of the high and low selling price of the stock on the date of the gift.

Mutual Fund Shares

Valuing mutual fund shares is rather straightforward. The fair market value of a mutual fund share is its public redemption (bid) price on the date of the gift. If a price is not available, the last public redemption price quoted by the fund is presumed to be the applicable public redemption price.

There are no certificates of ownership with mutual fund shares. Ownership is noted in an account statement. Since this reflects the involvement of a fund manager, keep in mind that gifts of mutual fund shares may take longer to implement and involve more paperwork.

Bonds

Since corporate bonds usually do not trade with the frequency of stocks, valuation may be a bit more tricky. Keep in mind, too, that a corporation usually offers several different types of bonds with different yields and maturity dates.

In some cases, the highest and lowest selling prices may not be publicly available for the date of the gift. However, if closing prices are available for the bond, fair market value can be determined by using the mean between the quoted closing price and the quoted closing price on the trading day prior to the valuation day.

If no sales of the bond took place within a reasonable period before the valuation day but sales took place during the valuation date, then the fair market value of the bond is its closing price. Usually, you can check the exchanges where the bonds are traded to do your valuations. But you very well may need to check with your broker or a bond specialist to help with your determination.

Note: Often the question is raised as to whether U.S. Savings Bonds are suitable for outright charitable gifts. Unfortunately, the answer is no. The U.S. Treasury restricts the lifetime conveyance of U.S. savings bonds (Series E, H, EE and HH). A gift may only be made by: (1) cashing in the bonds and donating the proceeds to a charitable organization, or (2) having the bonds reissued to the trustee of a revocable living trust in which the grantor is the income beneficiary and the charitable organization is the remainder beneficiary following the grantor’s death. Treasury also prohibits a donor from naming a charitable organization as a bond’s "co-owner" or death beneficiary. Consequently, virtually the only way to donate U.S. savings bonds is through bequests.

The IRS has announced that Series E United States Savings Bonds are to be valued at their redemption price for estate tax purposes, without allowing discounts for lack of marketability or income tax liability [TAM 200303010]. Individuals may be more inclined to bequeath these bonds to a charitable organization because the bequest qualifies for an estate tax charitable deduction at the bond's redemption value. Otherwise, the value of the bondsimage\emdash.jpgwithout the benefit of a valuation discountimage\emdash.jpgwould increase the size of the taxable estate.

Closely Held Stock

Many American entrepreneurs who start their own companies are also philanthropically inclined, so the potential for gifts of closely held stock is tremendous. Keep in mind that most closely held stock has virtually a zero cost basis, So the opportunity to escape a substantial capital gains tax has a strong appeal to many donors, especially those who want to leverage their gift or get the most out of their gift at the least cost. Owners of closely held stock, of course, have few ways to get money out of their companies for personal use without it being taxed as salary or dividend. But there is also a gift strategy that makes it possible:

Let's say a stockholder gives a charity shares of closely held stock worth $20,000. The donor will receive a charitable deduction on his or her income taxes for the full $20,000. Since the charity likely has no reason to keep the stock, it can sell it back to the stockholder's company (there's really no other market for the stock), and the company retires the stock so that the donor does not lose control of the company.

What's more, the removal of the $20,000 is not considered a dividend, and the arrangement is approved by the IRS so long as the corporation is not required to buy back the shares as part of a prearranged plan. The biggest problem with gifts of closely held stock is valuation. Stock transactions are generally too infrequent to establish a fair market value. So the IRS—to guard against over-valuation—has posted more rigid valuation guidelines. Here are just some of the factors that must be considered:

image\bullet.jpg The market price of stocks of corporations engaged in the same or similar kind of business

image\bullet.jpg The book value of the stock and the financial condition of the business

image\bullet.jpg The earnings and dividend-paying capacity of the business

image\bullet.jpg Sales of the stock and the size of the block of stock to be valued

image\bullet.jpg The economic outlook for the industry and the particular business

In addition to these factors, the value of a gift of closely held stock usually will have to be supported by a qualified appraisal prepared by a qualified appraiser.

Charities may be S Corporation shareholders. Donors who make contributions of S Corporation stock held more than one year generally may deduct the fair market value of the stock. The deduction, however, must be reduced by the amount of gain that would have been ordinary income had the donor sold the property. S shares may not be contributed to charitable remainder trusts. The "electing small business trusts" permitted to hold S shares may not be tax-exempt trusts such as charitable remainder trusts.

Restricted Securities and Stock Rights

In some cases, a donor may want to make a gift of restricted securities. These include unregistered securities, investment-letter stock, control stock or private-placement stock. Also, a donor may want to explore a gift of stock rights such as warrants or options. Stock rights (warrants and options) generally do not produce favorable tax results for the donor because they are usually held for less than one year. Since they would not produce long-term capital gain if sold, the deemed amount of the contribution must be reduced to the donor's basis, which usually will be zero. Therefore, the donor receives no deduction. But, the charity may receive a valuable economic right.

Corporations making a charitable contribution of stock options may claim a charitable deduction when the options are exercised (not when the options are given). The deduction is equal to the stock's fair market value on the date exercised over its option price.

Technical Considerations

When Is the Gift Completed?

While the rules for valuing gifts are fairly clear cut, donors often have questions about the actual completion date of the gift. This is because gifts of securities can be made in different ways. Sometimes they are hand delivered; sometimes they are mailed; most times they are transferred electronically.

So how does this interface with valuation? When the stock market is volatile, a day can make a huge difference in the stock price.

Here are some general rules to keep in mind about the timing of completed gifts:

image\bullet.jpg If the stock is mailed, it is the postmark on the envelope that determines the date of the gift - not when your institution actually receives the gift.

image\bullet.jpg If the stock certificate is hand delivered, the delivery date is the date of the gift.

image\bullet.jpg If the stock broker or banker makes the transfer to the charity's account, the actual date of transfer on the books is the date which determines the gift. If a new certificate must be issued (when a partial number of shares are transferred), then the gift is completed on the date the new certificate is issued.

image\bullet.jpg If the stock shares are transferred electronically through the Depository Trust Company (DTC), the effective date of the gift is the date of the electronic transfer.

Substantiation Requirements

To receive a charitable deduction, the Internal Revenue Service requires the donor to report on Form 8283 all gifts of securities valued over $500. No qualified appraisal is usually required for gifts of publicly traded stocks, regardless of the size of the gift. But if market quotations are not readily available, then the donor will need to have a qualified appraisal when claiming a deduction that exceeds $10,000 (though a partially completed appraisal summary must be attached to the return for stock valued between $5,000 and $10,000.)

 

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