The Limitations of Charitable Giving of Mutual Funds
If you've thought about donating mutual funds to charity, you'll be pleased to know that the Internal Revenue Service (IRS) appreciates your generosity, and it will reward you when it comes time to file your taxes. However, you'll need to know more than just the positive impact of your donation to take advantage of those benefits. You'll need to understand the tax implications for each kind of charitable donation as well.
You can't assume that you'll receive a full federal tax deduction for the value of your charitable donation of mutual funds. Although some of these gifts to charity are deductible in full, others are limited. There are a few common reasons why the tax deduction of charitable gifts of mutual funds might be less than 100%.
How Holding Periods Affect Your Tax Deduction for Charitable Giving of Mutual Funds
If you give away appreciated shares of your mutual fund to a qualifying charity, but you held the shares for 12 months or less, your tax deduction will be limited to the amount you invested in the fund. The only exception is if the cost basis is less than the full market value of the gift. In that case, the tax deduction is limited to the adjusted cost basis, which is the cost basis after taking into account things like capital distributions.
Assuming your mutual fund shares gain value, here's an example of what happens if you donate funds that you held for less than a year:
- You invest $1,500 in a mutual fund.
- After 11 months, the fund is worth $2,000.
- You gift the full value of $2,000 to your favorite charity 11 months after you purchase the fund.
- The tax deduction is limited to $1,500—the initial amount you invested (assuming you meet some other qualifications like income requirements).
If you hold the shares for longer than 12 months, you might qualify to deduct the full market value of the gift for federal income tax purposes. However, depending on qualifiers like your income level and the size of your charitable gift, it may take multiple years to see the full deduction on your taxes.
Adjusted Gross Income (AGI) Limitations
Generally speaking, you can deduct the full market value if you donate shares of mutual funds that you held long-term (at least 12 months and one day), but there are limitations. Your tax deduction is limited to 30% of your adjusted gross income (AGI) if you use the fair market value to determine your potential deduction. If you gift mutual funds that you held short-term (for 12 months or less), the ceiling on the deduction goes up to 50% of your AGI.
In the 2020 tax year, AGI limits for charitable giving deductions have been lifted—but only for cash contributions. This was part of the Congressional response to the COVID-19 pandemic, and it could complicate the calculations for some taxpayers about the most tax-efficient way to give to charity. It may be best to consult a tax professional to see what strategy works best for you.
Here's a bit of good news. If you face AGI limitations, you're allowed to carry forward the unused portion of the deduction for up to five years. That means you can deduct next year what you couldn't deduct this year. That same AGI limit will apply next year (30% for funds you held long-term, and 50% for funds you held short-term), but again, the remaining tax-deductible amount will roll over to the next year. The rollovers will continue until you've deducted the full amount of the gift, or until five years have passed since the original donation.
Itemized Deductions and Charitable Donations of Mutual Funds
If you give shares of your mutual funds to charity and want to claim a tax deduction, you must itemize your deductions on Schedule A and submit the schedule with your 1040. You can't claim the standard deduction.
This isn't advantageous for every taxpayer. You might find that the amount of the standard deduction to which you're entitled is greater than the total of all your itemized deductions. In this case, you'd end up paying the IRS more than you'd have to if you were to choose to itemize your tax deductions. The amount of your standard deduction depends on your filing status.
In tax year 2020, single filers can claim a standard deduction of $12,400, married couples can claim $24,800, and heads of household can claim $18,650. In tax year 2021, these figures increase to $12,550, $25,100, and $18,800, respectively.
Another part of the Congressional response to the COVID-19 pandemic gave taxpayers who claim the standard deduction the ability to deduct up to $300 for charitable donations. However, as with the lifted AGI limitations, this pandemic response stipulation applies only to cash donations.
You Must Give to Qualifying Charities
Keep in mind, too, that you can't simply give your mutual funds to your neighbor and expect to claim a tax deduction for your generosity. Only certain organizations are approved by the IRS to receive tax-deductible charitable donations. The IRS offers a searchable database of charities that qualify.
Most well-known charities, like Goodwill or United Way, are eligible. Many religious institutions, nonprofit schools, healthcare facilities, and first-responder organizations are also eligible. Once you have a charity in mind, check with the IRS to make sure the charity makes the list. You can enter the name of the charity, and the IRS website will search for it and tell you whether it's qualified.
Tax Law Changes Affect Charitable Donations of Mutual Funds
Tax laws change frequently, and individuals can be faced with differing income tax circumstances from year to year. For example, the Tax Cut and Jobs Act of 2017 eliminated some types of itemized deductions while increasing the standard deduction. Contact your tax preparer to determine which limitations and benefits apply to your situation.
The Balance does not provide tax or investment advice or financial services. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.