Charitable Donations: The Basics of Giving

Remember the adage "It's better to give than to receive"? If your financial goals include giving to causes that are important to you, you can strategize to make the greatest impact while potentially receiving tax savings too.

The tax aspects of charitable giving can be complex. It's always a good idea to consult a tax professional about your giving strategy. That said, here are a few ground rules:

• Request a receipt if you donate $250 or more to a single charity. If the donation is in cash, regardless of amount, you'll need a receipt or supporting bank records.
• Get an independent, written appraisal for gifts of property in excess of $5,000 ($10,000 for closely held stock). You won't need an appraisal for exchange-traded funds, bonds, or mutual funds.
• Subtract the value of any benefits you received for your charitable donation (for example books, tapes, meals, entertainment, and so on) before you deduct it.
• Itemize your deductions on your tax return if you think your total donations will exceed your standard deduction¹ and you want to receive a tax benefit for your charitable donations. If your standard deduction is higher, your donations won't reduce your tax bill, but you'll still be supporting your favorite charity—which is a good reason on its own to give. 
• Be aware of the annual deduction limits for donations to public charities, including donor-advised funds. For contributions of non-cash assets held more than one year, the limit is 30% of your adjusted gross income (AGI). Your deduction limit will be 60% of your AGI for cash gifts. Note that if you're planning a large donation that's close to or exceeds your AGI limit, you may carry over the excess contribution amounts up to five subsequent tax years. Consider talking to a tax professional before making your donation.

The tax advantages of a charitable contribution generally depend on three factors: the recipient (only donations to qualified charities are deductible), how you structure the gift, and the type of property you choose to give. Different types of property donations—whether its cash, business assets, or investments—offer different tax advantages and drawbacks:

Cash donations are simple, but as previously mentioned, make sure you keep a receipt from the charity or a bank record (such as a canceled check or statement) to substantiate your cash gift—no matter how small. 

You can deduct transportation costs and other expenses related to volunteering. However, the value of volunteer time isn't deductible.

You can donate almost any item—including old clothing, household goods, or vehicles—as long as it's in "good" used condition or better under IRS tax rules. If the property doesn't relate to the charity's mission, you may deduct the amount you paid for the property or the property's current reasonable value—whichever is less. If the property is related to the charity's mission—old clothes donated to the Salvation Army, for example—it's usually fully deductible based on its current reasonable value. Some charities will provide guidance, but it's ultimately up to you to determine the property's worth for tax purposes.

Ordinary income property normally includes assets like inventory held for sale by a business, artwork created by you, or manufactured items you produced. In addition, any short-term capital assets, such as stock, are considered to be ordinary income property if held for less than a year.

Typically, if the donated assets would have generated ordinary income if sold on the day of contribution, then the IRS limits your deduction to the asset's cost basis (the fair market value reduced by the amount of ordinary income or short-term capital gain that would have been realized). However, you may be able to take the full deduction if you include the appreciated value of the asset in your gross income on your tax return. If the property has decreased in value, your deduction could be further limited (see "Property or assets that have decreased in value").

You can usually deduct the full fair market value of appreciated long-term assets that you've held for more than one year and a day—such as stocks, bonds, mutual funds, or other personal assets like real estate that have appreciated in value. An additional benefit is you don't have to recognize any gains on the donation, which means you pay no capital gains tax on that property. 

Donating long-term assets—especially highly appreciated securities—instead of cash can be a very effective and tax-efficient way to support a charity. If your assets have appreciated in value, you can generally increase the amount of your potential deduction as well as your gift by contributing the securities directly to the charity instead of the cash generated by selling them.

Let's say Sarah and Steve are married, file a joint tax return, and want to donate $100,000 worth of stock to their local animal shelter. They are in the 37% federal ordinary income tax bracket and are subject to the 20% long-term capital gains tax rate, plus the 3.8% net investment income tax. They have two options: They could sell the stock and donate the cash, or they could just donate the stock directly to the charity.

For property that has decreased in value below its cost basis, the IRS has a special rule that says you can only take a donation deduction for the fair market value of that asset. In some situations, such as when you have shares of stock that have decreased in value to the point where you have losses, it may be better to sell that asset first and then donate the cash proceeds. By doing so, you may be able to reduce your tax liability by using your capital losses to offset any capital gains (known as tax-loss harvesting) and then donate the remaining cash to potentially get a deduction on your contribution.

While gifts of cash or appreciated investments can be given directly to a charity, it often makes sense to consider specialized charitable vehicles to make giving easier and to manage the tax benefits. If you give regularly, certain giving vehicles like donor-advised funds or private foundations can make sense.

Donor-advised funds, for example, allow you to make a donation of appreciated stock held long term and to receive a current-year tax deduction. You can then grant those assets out over time and have the remaining assets invested so they can potentially grow for future grants to worthwhile charities.

If you prefer to leave assets to charity but also earn income for a period of time, a charitable remainder trust (CRT) or pooled income fund is worth exploring. If you're age 70½  or older, you can donate a qualified charitable distribution (QCD) tax-free from an IRA directly to a qualified charity. A QCD can be used to meet up to $100,000 of the required minimum distribution for your IRA, and you don't have to include that distribution in your taxable income. However, you should note that there is no tax deduction for a QCD.

Each of these donation strategies and vehicles offers different benefits, but in the end, what really matters is helping an organization that matters to you—the tax benefits from a donation are just icing on the cake. So, compare your options and talk with a financial planner, tax advisor, and/or a philanthropic advisor to help determine the best way to give for your particular situation.