Making charitable giving more tax-efficient
Harvesting your portfolio’s gains can help your philanthropic dollar go farther — and potentially lower your tax bill. Here’s how you can make this strategy a regular part of your wealth planning.
WHAT PROMPTS YOU TO MAKE A CHARITABLE DONATION? For many of us, it’s typically a one-off response to a request from a nonprofit, or from a friend or colleague, which we acknowledge by writing a check. But you might consider taking a more deliberate, systematic approach to giving — one that may result in larger donations to the causes you believe in, as well as tax savings and a portfolio better aligned with your goals.
This approach is a variation on a popular investing strategy called tax-loss harvesting, in which investors claim investment losses as a way to reduce their tax bill. With “charitable gain harvesting,” you and your advisor identify assets with significant unrealized gains and donate them directly to charity. “The idea is that, in addition to harvesting stock losses, you also focus on the gains themselves, harvesting assets that have done well to use for your charitable gifts and to offset your tax obligations,” says Donald Greene, National Donor-Advised Fund Executive, Bank of America Private Bank.
Charitable gain harvesting, he adds, “can be a tax-planning tool that lets you step back and think about how and when to rebalance your portfolio, what appreciated assets you might harvest and how tax advantages may help inform your giving.”
“With ‘charitable gain harvesting,’ in addition to harvesting stock losses, you harvest assets that have done well to use for your charitable gifts.”— National Donor-Advised Fund Executive, Bank of America Private Bank
The power of donating directly
While cash gifts may be convenient, notes Tom Lawson, Endowment and Foundation Specialist at Bank of America Private Bank, “Assets that have gained value are almost always the most efficient way of making a charitable gift.” Why? Say you decide to sell a stock that has appreciated and which you’ve held for more than a year — you’ll owe capital gains tax on the difference between the stock’s tax basis (generally what you paid for the stock) and the sale price. However, by giving that asset directly to charity, you avoid any capital gains tax liability, and you can deduct the full market value from your income, subject to certain limitations based on your adjusted gross income.
Here’s an example: You want to sell investments worth $40,000 to fund charitable gifts. If those shares have appreciated, you could owe as much as 20% capital gains tax plus a potential 3.8% net investment income tax on that amount — leaving you with a smaller amount after taxes for your donation. By donating the stock directly to charity, the nonprofit would get the full $40,000 for its mission, and you could be able to deduct up to $40,000. “People are often surprised by the power of this approach, which effectively increases your charitable giving,” says Jennifer Erdelyi, Wealth Strategies Advisor, Bank of America Private Bank. “It’s truly a win-win,” she adds. For an illustration of how the strategy can work, click on “Magnifying the impact of your giving: A case study” below.
Integrate giving into your overall financial picture
Charitable gain harvesting can be integrated into your routine reviews. As you examine your entire portfolio with your advisor, consider your holdings and allocations and revisit how that mix of investments aligns with your financial goals. “Investors typically focus on their losses during this process,” Lawson says. “But this is also a great time to examine gains you might harvest for charitable giving. Making this discussion part of portfolio reviews provides an ongoing opportunity to discuss how your giving fits with your overall wealth planning.”
What’s more, you can use these discussions to establish a “generosity budget,” making charitable giving a deliberate process rather than a random response to solicitations. “We work with clients as they consider how much they can appropriately dedicate to their charitable interests,” says Erdelyi. “What amount do they want to give, and how does that relate to their cash flow and their financial goals?” Knowing how much you have budgeted can in turn guide you in looking for gains to harvest.
Preserving gains for the future
If the amount you’ve harvested for charitable giving is greater than the amount you’re prepared to donate in a single year, you can instead direct those sale proceeds into a donor-advised fund (DAF).
With a DAF, you get an immediate charitable deduction for your donation, and the proceeds from the sale of stocks or other assets are invested, offering potential tax-free growth. You can then decide which charitable organizations you’d like to support over time. This flexibility has made DAFs increasingly popular with donors; the number of DAF accounts has grown nearly 29% annually since 2017, and yearly contributions are at an all-time high.1
A DAF can also be a way to introduce younger family members to philanthropy. “Children often have different charitable interests than their parents,” Erdelyi says. “You could set up a DAF so that your kids can make grant recommendations for beneficiaries that are important to them.” That way, the gains you harvest now can plant the seed for charitable giving for generations.
Here’s another potential advantage a DAF offers: When the gains you’re hoping to donate come from more complex assets, such as a private business or real estate, many nonprofits may not be equipped to accept them — however, most DAF funds can. (To learn more, see “How to integrate complex assets into your giving strategy.”)
Being aware of these kinds of strategies can help you get the most out of your donations, Greene notes. “But that’s the technical side of giving,” he says. “Just as important is the emotional side, being able to support causes that have meaning for you.” By employing charitable gains harvesting, you have the potential to marry both sides — thoughtfully considering tax rules in order to make your giving more rewarding and powerful.
1 National Philanthropic Trust, “The 2022 DAF Report,” November 2022.
2 Assumes the appreciated stock had a fair market value of $500,000 and a tax basis of $385,000.
3 Subject to adjusted gross income limitations.
Merrill, its affiliates and financial advisors do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.