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If you're planning to make significant charitable donations in the coming year, consider a donor-advised fund (DAF). These accounts allow you to take a charitable income tax deduction immediately, while deferring decisions about how much to give — and to whom — until the time is right.
A DAF is a tax-advantaged investment account administered by a not-for-profit "sponsoring organization", such as a community foundation or the charitable arm of a financial services firm. Contributions are treated as gifts to a Section 501(c)(3) public charity, which are deductible up to 50% of adjusted gross income (AGI) for cash contributions and up to 30% of AGI for contributions of appreciated property (such as stock). Unused deductions may be carried forward for up to five years, and funds grow tax-free until distributed.
Although contributions are irrevocable, you're allowed to give the account a name and recommend how the funds will be invested (among the options offered by the DAF) and distributed to charities over time. You can even name a successor advisor, or prepare written instructions, to recommend investments and charitable gifts after your death.
Technically, a DAF isn't bound to follow your recommendations. But in practice, DAFs almost always respect donors' wishes. Generally, the only time a fund will refuse a donor's request is if the intended recipient isn't a qualified charity.
As mentioned, DAF owners can immediately deduct contributions but make gifts to charities later. Consider this scenario: Rhonda typically earns around $150,000 in AGI each year. In 2017, however, she sells her business, lifting her income to $5 million for the year.
Rhonda decides to donate $500,000 to charity, but she wants to take some time to investigate charities and spend her charitable dollars wisely. By placing $500,000 in a DAF this year, she can deduct the full amount immediately and decide how to distribute the funds in the coming years. If she waits until next year to make charitable donations, her deduction will be limited to $75,000 per year (50% of her AGI).
Even if you have a particular charity in mind, spreading your donations over several years can be a good strategy. It gives you time to evaluate whether the charity is using the funds responsibly before you make additional gifts. A DAF allows you to adopt this strategy without losing the ability to deduct the full amount in the year when it will do you the most good.
Another key advantage is capital gains avoidance. An effective charitable-giving strategy is to donate appreciated assets — such as securities or real estate. You're entitled to deduct the property's fair market value, and you can avoid the capital gains taxes you would have owed had you sold the property.
But not all charities are equipped to accept and manage this type of donation. Many DAFs, however, have the resources to accept contributions of appreciated assets, liquidate them and then reinvest the proceeds.
Requirements and fees
A DAF can also help you streamline your estate plan and donate to a charity anonymously. Requirements and fees vary from fund to fund, however. Please contact our firm for help finding one that meets your needs.
If your company owns real property, or you do so individually, you may not always be able to dispose of it as quickly as you'd like. One avenue for perhaps finding a buyer a little sooner is an installment sale.
Benefits and risks
An installment sale occurs when you transfer property in exchange for a promissory note and receive at least one payment after the tax year of the sale. Doing so allows you to receive interest on the full amount of the promissory note, often at a higher rate than you could earn from other investments, while deferring taxes and improving cash flow.
But there may be some disadvantages for sellers. For instance, the buyer may not make all payments and you may have to deal with foreclosure.
You generally must report an installment sale on your tax return under the "installment method." Each installment payment typically consists of interest income, return of your adjusted basis in the property and gain on the sale. For every taxable year in which you receive an installment payment, you must report as income the interest and gain components.
Calculating taxable gain involves multiplying the amount of payments, excluding interest, received in the taxable year by the gross profit ratio for the sale. The gross profit ratio is equal to the gross profit (the selling price less your adjusted basis) divided by the total contract price (the selling price less any qualifying indebtedness — mortgages, debts and other liabilities assumed or taken by the buyer — that doesn't exceed your basis).
The selling price includes the money and the fair market value of any other property you received for the sale of the property, selling expenses paid by the buyer and existing debt encumbering the property (regardless of whether the buyer assumes personal liability for it).
You may be considered to have received a taxable payment even if the buyer doesn't pay you directly. If the buyer assumes or pays any of your debts or expenses, it could be deemed a payment in the year of the sale. In many cases, though, the buyer's assumption of your debt is treated as a recovery of your basis, rather than a payment.
The rules of installment sales are complex. Please contact us to discuss this strategy further.