If you have a portfolio with highly appreciated assets, such as stocks that have performed exceptionally well, or concentrated holdings with a low tax basis, you may be looking for a way to manage the tax burden that comes with selling these assets. For many individuals and families, a Donor-Advised Fund (DAF) offers a strategic solution to make a charitable impact while enjoying significant tax advantages. A DAF provides a flexible, tax-efficient vehicle for giving that allows you to support the causes you care about on a timeline that works best for you, potentially extending your impact for generations. In this post, we’ll explore how DAFs can serve as a powerful tool for those with appreciated investments, along with some best practices for making the most of this opportunity.

What is a Donor-Advised Fund (DAF)?

A Donor-Advised Fund is a charitable investment account sponsored by a public charity, specifically designed for the purpose of supporting charitable organizations. Once you establish a DAF, you can contribute cash, securities, or other assets to the fund. After making the initial contribution, you recommend how those assets are invested and which charities will receive the funds, including the timing and amount of grants.

Here’s where the flexibility of a DAF shines: your contribution to the DAF is eligible for an immediate tax deduction, but you can choose to distribute funds to charities over time. This allows you to plan and manage your charitable giving in a way that aligns with both your financial situation and philanthropic goals.

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Tax Advantages of Donor-Advised Funds

When you contribute to a DAF, the IRS allows you to take an immediate tax deduction based on the value of the assets donated, with limits that vary depending on the type of asset. Cash contributions to a DAF are generally deductible up to 60% of your adjusted gross income (AGI), while contributions of appreciated assets like stocks are deductible up to 30% of AGI.

If your DAF contribution exceeds these AGI limits, the IRS allows you to carry forward any unused deductions for up to five additional years. This carryover can be particularly beneficial if you donate a large amount in a single year or if you’re using highly appreciated assets to fund the DAF. In this scenario, the deduction is gradually applied each year, ensuring you still benefit from the full deduction over time as you support your preferred causes through the DAF. This extended deduction period makes it easier to incorporate substantial charitable giving into your overall tax and financial strategy without wasting any of the potential tax benefits

1. Immediate Tax Deduction

One of the primary benefits of a DAF is the immediate tax deduction for contributions. In the year you make a donation to a DAF, you may receive a deduction for the fair market value of your gift. This can help offset a high-income year, especially if you have realized significant capital gains or have other income that places you in a higher tax bracket.

• Cash Contributions: You can typically deduct up to 60% of your adjusted gross income (AGI) for cash contributions to a DAF.
• Securities and Appreciated Assets: For contributions of publicly traded securities and other appreciated assets, you may be eligible to deduct up to 30% of your AGI. Notably, the deduction is based on the fair market value of the assets, not the original purchase price. This can be particularly advantageous if you have stocks with significant unrealized gains.

2. Avoid Capital Gains Tax

If you hold assets with substantial unrealized capital gains, such as stocks or mutual funds, donating these assets to a DAF allows you to avoid the capital gains tax you would incur if you sold them. For example, if you have a concentrated stock position with a low tax basis, donating a portion or all of these shares to a DAF can allow you to diversify your portfolio without realizing the gain or paying capital gains taxes. This can free up cash and reduce your tax burden, making it easier to achieve your investment and charitable objectives simultaneously.

3. Reduce Estate Taxes

For individuals with a high-net-worth estate, a DAF can also help reduce estate taxes. Since assets donated to a DAF are removed from your taxable estate, this strategy can be beneficial for those looking to minimize estate tax liability and support their preferred causes. A DAF offers a straightforward way to make a lasting philanthropic impact without the complexities often associated with other estate planning tools, such as private foundations.

Flexibility in Charitable Giving With a DAF

1. Control Over Timing of Distributions

While you receive the tax deduction in the year of your contribution, a DAF allows you to distribute the funds to charities over time, aligning your giving with personal milestones or pressing needs in the community. This makes DAFs an excellent tool for strategic, long-term philanthropic planning.

• Giving in High-Income Years: For individuals who experience sporadic income, such as business owners or tech professionals with equity compensation, DAFs provide flexibility. You can contribute in high-income years to reduce tax liability, then make grants over several years, even during lower-income periods.

2. Investment Growth for Greater Impact

After contributing to a DAF, you can recommend how the assets are invested. Over time, if the investments perform well, the growth in the DAF can increase the funds available for charitable giving, essentially amplifying your impact without additional out-of-pocket contributions.

• Potential for Greater Grantmaking Capacity: By investing the funds, your DAF can grow, enabling you to make larger or more frequent donations in the future. This strategy is particularly appealing for those who want to maximize their philanthropic footprint over their lifetime or leave a legacy of giving.

3. Legacy Giving and Family Involvement

A DAF can serve as a powerful legacy tool, allowing you to involve your family in philanthropy and pass on values related to giving and social impact. Many DAF providers offer options to name successor advisors, meaning that your children or other family members can continue to manage and grant funds from the DAF after your lifetime.

• Multi-Generational Giving: Involving your family in the decision-making process allows future generations to make a charitable impact, carrying forward your vision and values.
• Establishing a Legacy of Philanthropy: Many individuals use a DAF to create a formal plan for giving that will continue to benefit causes they care about long after they’re gone. This can include setting up annual grants or special initiatives in honor of your legacy.

Best Practices for Maximizing a Donor-Advised Fund

1. Donate Appreciated Securities First

To make the most of your tax advantage, prioritize contributing appreciated assets to your DAF. Donating appreciated securities not only maximizes your deduction but also shields you from capital gains taxes, allowing more of your wealth to support charitable causes.

2. Consider “Bunching” Charitable Contributions

Under the Tax Cuts and Jobs Act, some taxpayers may benefit from a strategy known as “bunching.” By contributing multiple years’ worth of charitable donations in a single year, you may be able to exceed the standard deduction threshold and itemize your deductions, receiving a larger tax benefit. Bunching works particularly well for those who contribute to a DAF, as it provides flexibility in distributing the funds over multiple years.

3. Review Investment Options for the DAF

Work with your financial advisor to choose an investment strategy within the DAF that aligns with your philanthropic timeline and goals. Some individuals opt for conservative investments to protect the principal, while others prefer more aggressive investments if they plan to let the fund grow over a longer period.

4. Communicate Your Goals and Preferences to Successors

If you intend for your DAF to continue beyond your lifetime, take the time to clearly communicate your goals to successor advisors. You may also include guidance on the types of causes or organizations you want them to support, ensuring that your philanthropic intentions are honored.

Making the Most of Your DAF

A Donor-Advised Fund provides a unique opportunity to combine tax-efficient giving with long-term philanthropic impact. For individuals and families with highly appreciated assets, a DAF offers an effective way to maximize charitable contributions while reducing tax liability. By investing the assets within the DAF, involving family members, and planning for legacy giving, you can create a powerful, multi-generational impact on the causes you care about.

Whether you’re looking to give in a high-income year, offset capital gains, or establish a family tradition of giving, a DAF offers the flexibility, tax benefits, and growth potential to help you meet your charitable goals. Before moving forward, consider consulting a financial advisor who can guide you in establishing a DAF that aligns with both your financial situation and philanthropic aspirations.

With the right strategy, a Donor-Advised Fund not only enhances your ability to give but also deepens your connection to the organizations and communities you support, creating a lasting impact for years to come.