If you have considered donating mutual funds to a charitable organization, you will be happy to know that the Internal Revenue Service (IRS) values your generosity. The agency may reward you with a tax deduction when it comes time to file your tax return. But there are rules for each type of donation.
Impact of Holding Periods
Your tax deduction will be limited to the amount of your investment in the fund if you donate appreciated stock to a qualified charity and held the stock for 12 months or less. The only exception to this rule is if the cost basis is less than the fair market value of the gift. In this case, your tax deduction is limited to the adjusted cost basis, which is the cost basis after items such as capital distributions.
Here’s what happens if you donate the money you invested for less than a year and the value of the mutual fund shares has increased. Let’s say you invested $1,500. The fund is worth $2,000 after 11 months. You donate the full value of the fund, $2,000, to your favorite charity after 11 months of buying the fund. Your tax deduction is limited to $1,500, the initial amount you invested, as long as you meet some other rules, such as income requirements.
You may be able to deduct the full fair market value of the gift for federal income tax purposes if you held the stock for more than 12 months. However, it may take multiple years to claim the full deduction, depending on your income level and the size of your gift.
Adjusted Gross Income Limitations
Often, you can deduct the full fair market value of your funds if you donate stock that you have held for a long time: not less than 12 months and one day. But there are limitations here as well. Your tax deduction is capped at 30% of your adjusted gross income if you used fair market value to determine it. The limit is up to 50% of your adjusted gross income if you donated mutual funds that you held for a short term of up to 12 months or less.
Note: The adjusted gross income limits for charitable contributions were raised in 2020.
Here is some good news: you are allowed to carry over the unused portion of the tax deduction for up to five years if you face adjusted gross income limits. You can deduct in the next year unless you are unable to deduct it this year.
The same adjusted gross income cap will apply next year (30% for long-term invested funds and 50% for short-term invested funds). The remainder of the deductible amount will be carried over to the next year. Carryovers will continue until you deduct the full amount for your gift or until five years have passed from the original donation.
Itemized Deductions and Mutual Fund Donations
You must itemize your deductions on Schedule A to claim a deduction for your gift. Submit Schedule A with your tax return Form 1040 if you donated your mutual fund shares to the charity and wish to claim a tax deduction. This means that you cannot claim the standard deduction. This is not a good option for all taxpayers. You may find that your standard deduction amount based on your filing status exceeds the total of all your itemized deductions. You could end up paying more to the IRS than you would have if you itemized the deductions in this case.
Single individuals can claim a standard deduction of $12,550 for the tax year 2021. Married couples can claim $25,100, and heads of households can claim $18,800. These exemptions increase slightly in 2022. Single individuals can claim a standard deduction of $12,950 in 2022, married couples can claim $25,900, and heads of households can claim $19,400.
Note:
A temporary tax rule for the years 2020 and 2021 allows taxpayers claiming the standard deduction to deduct up to $300 for charitable donations without itemizing, but this applies only to cash donations and not to mutual funds.
You must donate to a qualified charity
You cannot simply hand your mutual funds to your neighbor and expect to claim a tax deduction. Only certain organizations have been approved by the Internal Revenue Service to receive tax-deductible charitable donations. The IRS provides a tool to search for qualified charities on its website.
Most well-known organizations, such as Goodwill and United Way, are qualified. Many religious institutions, non-profit schools, healthcare facilities, and first responder organizations are also eligible. Check the IRS search tool to make sure the charity you are considering is listed.
Tax law changes can affect mutual funds
Tax laws often change. You may also experience changes in income tax circumstances from year to year. The Tax Cuts and Jobs Act eliminated some types of itemized deductions while increasing the standard deduction. Contact your tax professional to find out the limits and benefits that apply to you.
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Source: https://www.thebalancemoney.com/donating-mutual-funds-charity-limitations-2466694
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