Donor Advised Funds
How to save taxes and give to a charity using donor advised funds for your highly appreciated assets.
Being philanthropic is always hailed as generous, however, before you start donating your hard-earned dollars, I’d like to highlight a few strategies to reduce your tax liability by using a donor-advised fund while increasing your charitable giving impact.
Depending on your circumstances, there are five instances where a donor advised fund can serve as a powerful tax reduction tool.
As an experienced Certified Financial Planner® I would like to assist you in understanding exactly how to save taxes with a donor advised fund for your highly appreciated assets. First things first, let me provide a clear definition of what a Donor Advised Fund is.
What is a Donor Advised Fund?
A donor advised fund (DAF) is a charitable investment account that enables donors to manage their charitable donations in simple, tax-smart and meaningful ways. Donors can enjoy the best tax advantages available, make grants on their own flexible time table and build their enduring charitable legacy. Anyone can open a fund with an initial contribution of $5,000 or more, after which the fund is professionally managed and invested for future growth. Once a donor-advised fund has been established, the donor can make contributions to charities out of the fund’s assets at any time.
How Can a Donor Advised Fund Reduce Taxes?
Due to their structure, donor advised funds provide tax reduction opportunities in the following ways:
1. Income Tax Deduction
The charitable dollars in your donor-advised fund (DAF) can be invested before they are granted out. With market growth, your DAF balance can also grow. This makes even more money available for grant making. Moreover, while you can take an immediate tax deduction for the gifts you make to your DAF, you will not be taxed on any growth, since the assets belong to the DAF’s charitable sponsor.
2. Capital Gains Tax Avoidance
The donor will incur no capital gains tax on gifts of appreciated assets (i.e. securities, real estate, other illiquid assets). DAFs can reduce tax burdens after a windfall situation, such as receiving an inheritance, selling a business, or experiencing strong market returns. You can take an immediate tax deduction when you make a charitable contribution to your DAF, reducing your tax liability. DAF's allow you to recommend grants to your favorite charities over time, so that you can effectively pre-fund years of giving with assets from a single high-income event.
3. Estate Tax Avoidance
The DAF will not be subject to estate taxes.
4. Tax-Free Investment Appreciation
The investments in the DAF appreciate tax-free, providing the donor additional funds that they can use for charitable gain.
5. Alternative Minimum Tax (AMT) Reduction
If the donor’s income is subject to alternative minimum tax (AMT), the contribution to their donor advised fund will reduce their AMT impact.
Who should use Donor Advised Funds?
For those who do not make charitable contributions or who already make very significant donations, a donor-advised fund may not provide a tax benefit, although it may push forward tax savings that would normally be spread out over multiple years. For those who make gifts to charities on a regular basis, opening a donor-advised fund and pre- funding multiple years of donations during a single tax year can maximize both your ability to give charitably and your ability to generate tax savings, even under the new tax law. You really can have your cake and eat it too!
As an alternative to a donor-advised fund, some choose to start a private foundation to manage their charitable giving. A foundation is typically set up via a one-time large donation that is invested and managed by a board of trustees. However, due to the size of the contribution needed to start a foundation (>$1 million), the donor-advised fund is a much more viable option for most investors.
Gifts of Appreciated Assets
Perhaps the most tax-efficient way to contribute to a donor-advised fund is via a gift of appreciated securities. Your gift can be in the form of shares of individual stocks, bonds, mutual funds, ETFs, and/or closed-end funds. If you qualify for itemized deductions and donate appreciated investments directly to a donor-advised fund, you could, in theory, receive a double tax benefit:
- You generate tax savings from the tax-deduction of your charitable donation.
- You generate further tax savings by avoiding potential capital gains taxes.
Gifting appreciated assets can significantly reduce your tax liability and enhance the flexibility of your portfolio, making portfolio rebalancing less financially painful. Even with the preferential tax treatment of long-term capital gains, the amount of tax can be considerable, and donating appreciated assets can help minimize what you owe to the IRS.
Many donor-advised funds will also accept gifts of non-public securities and other often illiquid assets such as artwork. For some donors, this can be a means to overcome the lack of liquidity in these appreciated private assets and to meet their charitable giving goals at the same time.
Donor-advised funds can help make charitable giving easy and highly tax beneficial. They provide the flexibility to make charitable contributions at your convenience, while simultaneously maximizing the tax deductibility of those contributions by bunching them into a single year.
As always make sure to consult with a tax professional before implementing any tax strategies to make sure they are appropriate for your situation. So now you know how to give to others while also improving your financial situation, a win-win!
Thank you for reading!