Basis is used to determine capital gain on the transfer of appreciated assets, such as stock or real estate. Donors should provide the basis of appreciated assets used to fund life income gifts such as charitable gift annuities. The basis and the fair market value of the gift will determine the tax-free income, ordinary income, and capital gain income portions of the gift annuity payments.
What is Basis?
Basis terminology includes cost basis, original basis, adjusted basis, step-up basis, and carryover basis. The cost basis or original basis or original cost basis is the cost or purchase price of the asset plus any additional expenses related to the purchase such as commissions or fees. The cost basis may change or adjust over time with increases, such as capital improvements or gift tax paid. There also may be decreases for depreciation or insurance reimbursement. The adjusted basis is the cost basis plus or minus these adjustments.
Inherited assets will receive a step-up basis for the recipient. The value of the asset on the date of death will be the cost basis in the hands of the recipient. When an asset is gifted, the cost basis for the recipient will be the carryover basis. That means the donor’s adjusted basis will be the gift recipient’s cost basis.
Why is Basis Important?
Basis is an important part of the discussion when transferring appreciated assets. Selling appreciated assets, such as real estate or stocks, will trigger realized capital gains when the sale price is more than the adjusted basis, or capital loss if the sale price is less than the adjusted basis. Donating appreciated assets can reduce or eliminate capital gain income.
Appreciated assets include stocks and bonds, real estate, business assets, and personal property. When appreciated assets are sold, the sale price minus the adjusted basis equals the realized capital gains or capital losses. When assets are transferred as an outright gift the donor will not recognize capital gains. If the appreciated assets are donated to a charity in exchange for a life income gift, the donor will recognize a portion of the capital gains.
Capital gain income is typically taxed at a lower rate than the ordinary income tax rate under federal tax rules. If the appreciated property was owned for more than one year before the sale, the capital gain will be long-term capital gain. If the asset was held for one year or fewer, then the gain will be short-term capital gain which is taxed as ordinary income.
How does Basis Affect Planned Giving?
Charitable gifts of appreciated property provide the donor with a charitable deduction and reduced (or even no) capital gain income. If a donor makes an outright gift of long-term appreciated property to a qualified charitable organization, no gain will be recognized. If the donor makes a gift to fund a charitable gift annuity or charitable remainder trust, the donor may recognize a portion of the capital gain.
Gifts of appreciated property to fund a charitable gift annuity reduce the donor’s overall recognized gain. If the donor sold the property outright, the recognized gain (immediate taxable gain) would equal the realized gain (sales price minus adjusted basis). If the donor is not an annuitant, then the reduced capital gain is recognized on the date of the gift. If the donor is an annuitant, then the recognized gain will be reported through the annuity payments over the life expectancy of the donor/annuitant. With a gift of appreciated assets, the total recognized gain is a portion of the realized gains. The donor recognizes less capital gain overall with a life income gift, and the capital gain is spread out over the life of the annuity.
The capital gain income is reflected in the taxation schedule of the annuity payments. The annuity payments for cash donations used to fund life income gifts will include tax-free income and ordinary income. The annuity payments for gifts of appreciated property will include tax-free income, ordinary income, and capital gain income. The tax-free and capital gain income portions of the annuity payments are based on the annuitant’s life expectancy, after which the annuity payments will be entirely ordinary income.
Example: 72 year-old with $50,000 Appreciated Stock with a $15,000 Adjusted Basis
Option 1: Sell Stock
- No Charitable Deduction and Capital Gains Tax Due
- Income Tax Charitable Deduction: $0
- Total reportable capital gains: $35,000 ($50,000 - $15,000 = $35,000)
- Capital gains tax: $7,000 ($35,000 x 20% federal capital gain tax = $7,000)
Option 2: Fund 6.6% Charitable Gift Annuity, Single Life – Donor is NOT Annuitant
- Charitable Deduction and Capital Gains Tax Due
- Income Tax Charitable Deduction: $17,981
- Annual Annuity Payment Total: $3,300
- Tax-free portion of payments: $2,207.70
- Ordinary Income portion of payments: $1,092.30
- Capital Gains portion of payments: $0
- Number of years to report gain: 0
- Capital Gain reported for year of gift: $22,413.30
- Total reportable capital gains: $22,413.30
- Federal Capital gains tax: $4,482.66 ($22,413.30 x 20% = $4,482.66)
- Total amount of capital gains on finding assets permanently forgiven by IRS: $35,000 - $22,413.30 = $12,586.69
Option 3: Fund 6.6% Charitable Gift Annuity, Single Life – Donor is Annuitant
- Charitable Deduction and Capital Gains Tax Spread Out Over 14.5 Years
- Income Tax Charitable Deduction: $17,981
- Annual Annuity Payment Total: $3,300
- Tax-free portion of payments: $662.31
- Ordinary Income portion of payments: $1,092.30
- Capital Gains portion of payments: $1,545.39
- Number of years to report gain: 14.5 years
- Total reportable capital gains: $22,413.30
- Federal Capital gains tax: $4,482.66 spread out over 14.5 years* ($22,413.30 x 20% = $4,482.66)
- Total amount of capital gains on finding assets permanently forgiven by IRS: $35,000 - $22,413.30 = $12,586.69
*Capital gains tax amount may vary with future tax rate changes
Where Do You Find Basis?
The basis should not be confused with the fair market value of the gift. The value of a gift of publicly traded stock is based on the median trading value of the stock on the date of the gift. To be clear, the value of the gift is the value of the asset on the date of the gift, not the value of the asset when sold by the charity. The basis of the gift cannot be determined by the purchase price alone. Basis can be complex, especially for mutual funds. The donated shares could have been purchased years ago at different times. Even if the shares are for the same traded company, the basis may not be the same for all the shares. The adjusted basis should be provided by the donor or donor’s financial advisor.
Be sure to ask the donor for the basis when discussing life income gifts funded by stock, real estate, or other appreciated assets. If the donor does not provide the basis, it is best not to guess and instead use a $0 basis in the illustration. This may help encourage the donor to provide the basis, so the annuity payment taxation schedule accurately reflects the capital gain portion.
