Tax Strategy: Stock Donations and Tax Loss Harvesting
overview
Tax Loss Harvesting is a financial strategy designed to offset the taxes that would be applied to capital gains earned during the tax period.
Stock donation strategies approach to improve your portfolio to spare more on your taxes.
Cocatalyst makes the donation process as simple as giving a credit card.
The market never goes up forever. There are often corrections and recessions that cause sharp drops in stock prices. If you are a long-term investor who contributes to charity, you want to implement strategies to reduce and even eliminate your capital gains taxes.
Tax-loss harvesting is a common strategy for investors looking to offset their gains. It works like this: Identify shares in your portfolio that have decreased in value since you purchased them. Sell those shares and take the capital loss. Then, use the cash to invest in a similar asset. Tax-loss harvesting is commonly used by financial advisors and robo-advisors to optimize returns.
In this article, we’ll cover 3 different scenarios to illustrate the benefits of tax-loss harvesting:
1. Buying a stock, tax-loss harvesting, and then donating
2. Buying a stock, holding, and then donating
3. Buying a stock, selling it for cash, and then donating
Scenario 1
Say you own Vanguard Total Stock Market ETF, VTI. You purchased $10,000 of VTI in February of 2020, and in April, you were at a large loss. You sold the shares to tax loss harvest for a total deduction of $2,500. That loss is reported on your taxes to reduce your income for the year. For high-income earners, you can get up to 49% of the loss back on your tax return; in this case, you could receive $1,225 in tax credits.
On the same day, you sold the VTI, you purchased $7,500 of Schwab U.S. Broad Market ETF, SCHB, an ETF with nearly identical holdings to VTI. Over the course of the year, it rises in value to $12,000, representing a gain of $4,500, and you then decide to donate the shares to a charity.
Normally if you sold, you could owe up to 37% in capital gains tax on this amount, which would be $1,665. However, by tax-loss harvesting and donating stock, you locked in 3 tax optimizations: tax-loss harvesting, avoidance of capital gains, and tax deductions for donating. You’ll get the full $12,000 tax deduction for the donation, the tax credits for your tax harvested loss ($1,225), and you saved the capital gains from the final gain ($1,665).
Scenario 1 Savings: $2,890
Scenario 1 Charitable Deduction: $12,000
Scenario 2
Now, say you hold on to your VTI ETF that you purchased for $10,000 until it appreciates to $12,000. In this case, you have no available credits from the loss. By donating your $12,000 of VTI, you still save the $740 in potential capital gains tax on the $2,000 gain, and you are able to write the full $12,000 off on your taxes.
Scenario 2 Savings: $740
Scenario 2 Charitable Deductions: $12,000
Scenario 3
Instead, let’s say you choose to sell your VTI holdings for cash, and then donate the cash to the charity. If you sell your appreciated $12,000 in VTI, you are liable to pay up to 37% of your $2,000 gain in capital gains tax, in this case, $740. That would leave you with $11,260 to donate to the charity of your choice, and $11,260 to write off on your taxes.
Scenario 3 Savings: $0
Scenario 3 Charitable Deductions: $11,260
Summary
| Strategy | Taxes Avoided | Deduction for Donation |
|---|---|---|
| Tax-loss Harvest and Donate Stock | $2,890 | $12,000 |
| Hold and Donate Stock | $740 | $12,000 |
| Sell Stock and Donate Cash | $0 | $11,260 |
In summary, if you combine stock donations with tax-loss harvesting, you are able to offset and avoid paying capital gains tax while increasing your deductions thanks to charitable contributions. In this example, you save $2,890 more and deduct $740 more from your taxes by combining tax-loss harvesting and donating appreciated stock.
Tax-loss harvesting and donating stock are two excellent ways to optimize your portfolio to save more on your taxes. Using a stock donation service such as Cocatalyst makes the process as simple as donating cash. Learn more about Deducting Stock Donations on your Tax Returns. Visit our article on How To Donate Appreciated Stock to a Charity to learn more, or visit our Start a Stock Donation page if you’re ready to donate today.