Taxes – ah, our ever-present certainty. While none of us can escape them (and honestly, we shouldn’t seek to), we can certainly strategize for them. When it comes to being tax-savvy while maintaining a philanthropic heartbeat, Donor Advised Funds (DAFs) are a key tool.
Let’s lay some groundwork first. With recent tax reforms, the standard deduction has seen a generous uptick. For many, this means itemizing deductions is much more rare. Enter the challenge: How do you maintain your charitable endeavors without letting that larger standard deduction go to waste? The answer: By being clever and using a Donor Advised Fund.
What Is a Donor Advised Fund?
A Donor Advised Fund (DAF) is akin to a charitable savings account. You contribute money or assets to the fund, get an immediate tax deduction, and then recommend grants from the account to charities over time. The fund is managed by a sponsoring organization, such as Fidelity Charitable, which handles the investments and disbursements.
It’s a flexible way to support causes you care about while maximizing tax benefits.
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How Does a Donor Advised Fund Work?
Here’s the magic behind it:
1. Front-loading Your Donations: With a Donor Advised Fund, you can contribute several years’ worth of donations in one go. This way, you maximize your itemized deductions in a single year, surpassing that beefed-up standard deduction. When you ‘jump the hurdle’ of the standard deduction, you want to go as high above it as possible.
2. Staggered Giving: While you front-load the donation into the DAF, the actual distribution to your chosen charities can be staggered over multiple years. This means your favorite causes can continue to receive support consistently.
3. Tax-Free Growth: The funds in a DAF have the potential to grow tax-free. More funds mean more impact when you eventually distribute them.
4. Flexibility: You get the immediate tax benefit when you contribute, but you can take your time deciding which (& when) charities benefit from your donation.
Give to Caesar
Now, I’m not saying we should shirk our responsibilities. Taxes play a vital role in our society and it is important to pay our fair share. A wise man once said, “Give to Caesar what is Caesar’s” but let’s not leave a tip! In short, Donor Advised Funds allow us to harmonize our charitable impulses with smart tax planning.
As always, it’s crucial to chat with a professional before making any decisions. Tax laws can be intricate, and having a guiding hand can make all the difference.
Until next time, cheers to wisdom and shrewdness.
Donor Advised Funds Frequently Asked Questions (FAQ)
How Do I Gift Real Estate To A Donor Advised Fund?
Gifting real estate to a Donor-Advised Fund (DAF) is possible, but it’s a complex process. It involves transferring ownership to the DAF, which then sells the property and uses the proceeds for charitable grants. While this can be beneficial in certain cases, for about 90% of clients, we typically recommend gifting highly appreciated stocks or mutual funds instead. The transaction is much simpler and still provides significant tax advantages for our clients.
Why Gifting Stocks is Beneficial:
Gifting appreciated stocks allows you to avoid capital gains taxes and claim a charitable deduction for the full fair market value of the stock. Here’s a real-world example to illustrate:
- Cost Basis of Stock: $10,000
- Current Value of Stock: $50,000
- Unrealized Capital Gain: $40,000
Option 1: Sell the Stock and Donate Cash
If you sell the stock:
- You’ll pay $8,000 in capital gains tax (assuming 20% long term capital gains tax rate of the $40,000 gain).
- This leaves you with $42,000 to donate.
- You can deduct $42,000 for the donation, but you’ve already lost $8,000 to taxes.
Option 2: Donate the Stock Directly
If you donate the stock directly to a DAF:
- You avoid the $8,000 in capital gains tax entirely.
- You get a charitable deduction for the full $50,000 fair market value.
- The DAF sells the stock tax-free, so the entire $50,000 funds your charitable giving.
Key Advantages of Gifting Stocks:
- Avoid Capital Gains Taxes: No taxes on the stock’s appreciation.
- Maximize Charitable Impact: The charity receives the full value of your gift.
- Simpler Process: No appraisals or legal complexities like with real estate and the transaction can be down seamlessly between accounts at the same custodian.
This makes gifting appreciated stocks an easy and highly effective way to support the causes you care about while maximizing your tax benefits.
What Are the Tax Benefits of Contributing to a Donor Advised Fund?
A Donor-Advised Fund (DAF) is a potent way to maximize your charitable impact while garnering significant tax benefits. Here’s how contributing to a DAF can benefit your financial strategy and philanthropic goals:
1. Immediate Tax Deduction
When you make a donation to a DAF, you get to take the tax deduction immediately in the year of the donation. The limits for deductions are quite liberal, enabling:
- Up to 60% of your adjusted gross income (AGI) for cash donations
- Up to 30% of your AGI for non-cash assets like stocks, mutual funds, or real estate
This makes DAFs an excellent strategy for individuals who want to reduce taxable income in high-earning years.
2. Avoid Capital Gains Taxes
You can avoid capital gains taxes by donating appreciated assets—such as stocks or real estate—directly to a DAF. For example:
If you sell $50,000 of stock with a $10,000 cost basis, you would typically owe $8,000 in capital gains tax, assuming a 20% tax rate.
By donating the stock to a DAF, you avoid this tax entirely, preserving more value for charity.
3. Tax-Free Growth
Once your assets are in a DAF, they can be invested. Any growth in the fund is tax-free, allowing your charitable contributions to grow over time and create a larger pool for future giving.
4. Bunching Contributions for Maximum Deduction
If your itemized deductions are less than the standard deduction, you could try a bunching strategy with a DAF. This means making several years of charitable contributions in one year to get the total over the threshold and allowing you to itemize and take a higher deduction.
5. Estate Tax Efficiency
Contributions to a DAF decrease the size of your taxable estate, potentially lowering estate taxes, while allowing you to leave a lasting legacy in your charitable areas of passion.
Example: Taxes Applied in Action
Let’s say you have highly appreciated stock:
Cost Basis: $10,000
Current Value: $50,000
Capital Gain: $40,000
You sell the stock:
You owe 8,000 dollars in capital gains tax, using a 20% capital gain on 40,000 dollars.
You give the remaining 42,000 dollars and take the deduction.
If you donate that stock to a DAF:
You save $8,000 in capital gains taxes.
You are able to deduct the full $50,000, maximizing your tax savings.
Why Use a Donor Advised Fund?
Donor-Advised Funds are ideal for individuals who want to streamline their giving, support multiple charities, and optimize their tax savings. Whether you’re looking to make an immediate impact or grow your contributions over time, a DAF provides the flexibility and financial efficiency to align your charitable giving with your financial goals.
Work With an Expert
As a seasoned financial advisor, I work with clients to maximize the tax benefits of their charitable giving strategy. Contact me today to explore how a Donor-Advised Fund can help you increase your philanthropy and financial planning.
Together, with your CPA, we can craft a charitable giving strategy to maximize your impact while reducing your tax burden.
Can a QCD Go To a Donor Advised Fund?
No, a Qualified Charitable Distribution (QCD) cannot go directly to a Donor-Advised Fund (DAF).
The IRS specifically prohibits QCDs from being made to Donor Advised Funds or certain other supporting organizations. A QCD, which allows individuals aged 70½ or older to donate up to $100,000 annually from their IRA directly to a qualified charity, must be directed to an IRS-qualified public charity that is not a DAF.
Alternatives for QCDs:
If you’re interested in using a QCD but also want to achieve flexibility similar to a DAF, consider directing your QCD to:
- A specific public charity that accepts QCDs and uses the funds for immediate impact.
If you’re interested in a combination of strategies, we can help create a plan to use QCDs alongside other tools, such as DAFs, for maximum tax and charitable benefits.
What Happens To a Donor Advised Fund After Death?
Many Donor Advised Fund custodians allow for you to name multiple successors to take over management of grants after your death. This is similar to naming a trustee to manage your trust once you are no longer able to do so yourself.
