The Tax Benefits of Donor-Advised Funds

May 11, 2022
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Recent tax code changes have made it harder to deduct charitable donations to 501(c)(3) organizations like churches and other nonprofits. You want to support your favorite charities, but it is also important to have the tax benefits that should be attached to these donations. You may want to consider another alternative to standard direct donations.

What is a Donor-Advised Fund?

What we’re talking about here is a donor-advised fund. These funds are becoming increasingly popular as the tax codes continue to change and evolve. The number of donor-advised funds has exploded over the past few years. Most importantly, they offer a tax-advantaged solution that allows you to donate the way you want while realizing the tax benefits you deserve.

Many national investment firms have created successful donor-advised funds. These commercial funds will hire an affiliated for-profit investment firm to manage the assets in the accounts for a fee that varies based on the account balance. There are also plenty of private donor-advised funds, community foundations and various solutions you can discuss with your personal financial advisor.

How Do Donor-Advised Funds Work?

Here’s a simple example of how a donor-advised fund works:

You donate $100,000 to the fund today. You get the $100,000 tax deduction on this year’s tax return. From that fund, you then donate $10,000 per year to your desired nonprofit organization(s). The other money left in the fund is invested and continues to grow tax-free, which allows you to donate even more to your favorite charities over time.

You always have the option to donate cash to a donor-advised fund. This can include money coming from a tax-deferred IRA or 401(k) account. Many funds will also accept non-cash donations, including:

  • Real Estate
  • Stocks, Bonds and Mutual Fund Shares
  • Privately Owned Company stock
  • Cryptocurrency
  • Life Insurance
  • LLC and Limited Partnership Interests

Tax Advantages of Donor-Advised Funds

It’s actually a great tax strategy to donate stocks or mutual fund shares to a donor-advised fund. If you have owned the stock for more than one year, you will get a tax deduction equal to its fair market value at the time of the donation. In addition, you won’t have to pay any capital gains tax on the appreciated value of the stock.

Let’s say you own 1,000 in shares of a certain stock. You paid $10,000 for the shares originally and now they are worth $100,000 today. You would establish a donor-advised fund that allows you to donate this stock to your favorite charity. They receive the full $100,000 value. You receive a $100,000 charitable tax deduction. And, you don’t pay any federal tax on the $90,000 capital gain!

There are many benefits to donor-advised funds. You’ll be able to donate more to the organizations you want while still taking advantage of the valuable tax benefits for your charitable contributions. It can be a true win-win situation if managed properly.

To learn more about donor-advised funds and other tax-advantaged charitable giving solutions, contact Illumination Wealth today and schedule a private consultation with one of our leading financial advisors.