Can you leverage charitable donations to reduce the tax you owe from capital gains? In many cases, yes—particularly when appreciated assets are donated directly to qualified charitable organizations or through donor-advised funds. Often, investors begin considering this approach as tax season comes or as part of their overall investment strategy, but it takes know-how of how charitable donations are treated by the IRS, as well as the specific rules for capital gains taxes.
Below, Realized 1031 has shared an article to address this question and provide guidance to investors.
A Recap on Capital Gains Tax
Capital gains are any profit you make after you sell an asset for more than what you initially paid. Real estate, stocks, and bonds are some examples of assets that appreciate and result in capital gains.
Let’s say that you bought an apartment complex for $700,000. After holding the property for a few years, you sold it for $900,000, thanks to favorable market conditions. The sale resulted in $200,000 in capital gains.
Since they’re a form of income, capital gains are taxable. There are two ways these profits are taxed based on how long you held the asset. Profit from assets you owned for less than a year is considered short-term capital gains and is taxed as ordinary income. Meanwhile, the income from an asset you held for longer than a year is categorized as long-term capital gains. This income follows capital gains tax rates, with 20% as the maximum federal rate.
Based on our example above, you’ll need to pay $40,000 in capital gains taxes if you’re in the highest tax bracket. Given the potential impact on after-tax returns, investors often explore tax-mitigation strategies in consultation with financial and tax advisors. One such approach includes charitable giving, which—when structured properly—may help offset or reduce capital gains tax exposure.
As such, investors have been trying to find ways to reduce, delay, or eliminate these taxes to preserve their wealth. One such strategy is making charitable donations.
Can Charitable Donations Reduce Capital Gains Tax?
There are a few ways charitable donations — defined as the gift of cash or property to a nonprofit organization — can help reduce your tax burden, but eligibility depends on IRS rules and proper planning.
- Donating the Appreciated Asset: If you donate long-term appreciated assets (held over one year), such as stocks or real estate to a qualified 501(c)(3) charity, you may be eligible for an income tax deduction based on the asset's fair market value. You also get an income tax deduction for the fair market value.
- Utilize Donor-Advised Funds (DAFs): DAFs allow you to contribute appreciated assets to a sponsoring charitable organization, receive a potential immediate charitable deduction, and recommend how those funds are granted over time. Because the DAF liquidates the asset within the tax-exempt structure, the transaction typically does not trigger capital gains recognition for the donor.
Charitable strategies are subject to IRS rules, such as adjusted gross income (AGI) limits, qualified appraisal requirements, and substantiation rules. Always consult with a qualified tax advisor or legal professional to determine suitability for your specific situation.
Other Strategies to Manage Capital Gains Tax Liability
While donating appreciated assets can be a tax-efficient way to potentially mitigate exposure to capital gains tax, the act of giving away a potentially large sum might represent a significant income loss for some investors. There are alternatives you can try, such as 1031 exchanges, to manage capital gains liability without reducing your income substantially.
This strategy does not eliminate the tax obligation but postpones it until a future taxable event, such as a sale, without further reinvestment. By deferring taxes through a 1031 exchange, investors may align their capital gains recognition with future financial planning objectives. However, these transactions involve strict timing, documentation, and use of a qualified intermediary as required under IRS regulations. It is important to consult a tax advisor or legal professional to determine suitability based on your specific situation.
Wrapping Up: Charitable Donations and Capital Gains Tax
You can leverage charitable donations to reduce capital gains taxes, and there are a few ways this can happen. Whether you want to donate your appreciated assets outright or use tax loss harvesting strategies, the best strategy is one that fits your investment needs and philanthropic goals. Always consult with a tax professional and other experts before making charitable donations to ensure that you understand the full tax implications of this endeavor.
The tax and estate planning information offered by the advisor is general in nature. It is provided for informational purposes only and should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.
Article written by: Story Amplify. Story Amplify is a marketing agency that offers services such as copywriting across industries, including financial services, real estate investment services, and miscellaneous small businesses.
Sources:
https://www.investopedia.com/terms/c/capitalgain.asp
https://www.bankrate.com/investing/long-term-capital-gains-tax/
