Donor-Advised Funds Can Allow Your Clients to Donate Highly Appreciated Assets and Avoid the Capital Gains Tax.

By Bruce Hosler EA, CFP®, CPWA®, AIF®, CEPA®

Donor-Advised Funds (DAFs) are attractive to our clients for many reasons. One of the big reasons is that a DAF provides you with the opportunity to add value by providing guidance around the rules of donating highly appreciated assets.

Many people are accustomed to being solicited every year by various charities seeking cash donations, so it is common to make charitable cash donations annually.

The state of Arizona supports specific classes of charities by offering state tax credit programs. Generally, one of the requirements of Arizona tax credit donations is that they must be in the form of a cash donation. Donations “in-kind” typically don’t qualify for the Arizona state tax credits.

If you look at the instructions on the Arizona State Tax Form 321, it states, “Arizona law provides for a credit for cash contributions made to certain qualifying charitable organizations (charities).”

Donor-Advised Funds can be used creatively to convert highly appreciated assets into cash donations. Let’s consider some of the “complex assets” one may own that can be donated to a Donor-Advised Fund:

Highly appreciated stock
Private company stock
Restricted stock
Partnership interests
Non-publicly traded stock
Hedge fund interests
Insurance policies
Stock options
Foreign-traded stock

Real estate
Collectibles
Trusts
Intellectual property
Commodities
Tangible Personal Property (collectibles, artwork, vehicles, jewelry, coins, timber)

Are you considering all of these options when you are advising clients? Typically, we find the flexible optionality that a Donor-Advised Fund offers – which allows gifting to multiple charities over many years avoiding capital gains tax – is preferred when making a sizable in-kind donation.

Sometimes clients may want to donate only some of the appreciated assets. With wise coaching, you can help them understand that they may have options to make partial gifts of these highly appreciated assets.

I hope you are thinking about how you might get creative in helping your high-net-worth clients who are philanthropically inclined to use a Donor-Advised Fund to help accomplish some of their goals. There is the potential of avoiding capital gains tax while helping their favorite charities sometimes over a number of years.

Clients love the idea that they can stay engaged by directing donations from the Donor-Advised Fund every year as they help the causes that are near and dear to their hearts.

Before we get too far into the weeds, I want to pause and let you know that not everything is perfect when you use a Donor-Advised Fund. Below are examples of the complexities and key considerations you will want to consider.

You can’t have a binding sales agreement or debt when donating real estate. It must also have a marketable value.
If you give small business stock (C-Corp, S-Corp, or partnership/LLC), the DAF may only hold the active business interests for 60 months.
Transfers of business interests may be subject to the board, other shareholders, or partnership or partners’ approval.
S-Corps and partnership/LLC interests may subject the charity to unrelated business income tax (UBIT).

The appraised value of some business assets may be subject to a marketability or minority interest discount.
Tangible property is often difficult to value and frequently requires specialists to appraise and evaluate for proper tax substantiation.
Donors may not have evidence of the basis for inherited property or assets acquired long ago.
Tangible property is almost always limited to basis due to the related-use rule.

This list highlights some limited areas you should be aware of when advising clients to donate these types of appreciated assets to a Donor-Advised Fund.

Donors with a social annual gifting obligation, such as an annual scholarship donation (to a college alma mater), tithes or other annual commitments, such as to their church, can usually benefit from this strategy.

As discussed earlier in this article, Arizona Tax Credits must be made by cash donation. The Donor-Advised Fund can be used to donate highly appreciated assets in kind, and then the donor can make a “cash donation” from the Donor-Advised Fund to charities that qualify for the tax credit.

In summary, DAFs are a powerful tool for managing your client’s charitable giving and potentially avoiding capital gains tax. However, they are complex and not suited for everyone. As tax professionals, always consult with a financial professional before making any recommendation regarding Donor-Advised Funds to make sure they are suitable for the client’s situation.

Bruce Hosler, EA, CFP®, CPWA®, AIF®, CEPA® is founder and principal of Hosler Wealth Management and an ASCPA member. He can be reached at info@hoslerwm.com. Hosler will also be speaking at Converge, the ASCPA’s annual conference. You can register for the event at www.ascpa.com/converge.

This material is intended for informational/educational purposes only and should not be construed as tax or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Consult with a qualified financial advisor or tax professional before making any decisions based on this information.

Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results.