LOSING STOCKS, WINNING SITUATION

The stock market is falling! Perhaps some of your stocks have even dropped below what you originally paid for them. You may be surprised to learn that there are ways to turn those “loser” stocks into a winning situation – for you, your heirs, or even your favorite charity.

Charitable Contributions

Many donors are used to giving appreciated stock instead of cash because they get a deduction and avoid capital gain.

For instance, if you purchase stock at $1,000 and the value of that stock appreciates to $10,000, upon sale of the stock you have a capital gain of $9,000. Despite the fact that you have made quite a profit, you must pay capital gains tax on that $9,000; taxes which can exceed $1,800.

To avoid paying that tax, many people donate the appreciated stock. By doing this, they enjoy the $10,000 tax deduction without paying tax on their gains. The recipient charity enjoys the full value of the stock appreciation, tax free.

However, there is a fundamental point many people forget.

If you plan to give stock which is worth less than you paid for it, you would be much better off to sell it and take the tax loss, rather than giving the depreciated stock to a charity.

Why is this? Say you purchased stock costing $10,000, now valued at only $1,000. If you sell the stock and donate the amount of $1,000, you can take a tax loss deduction (a tax write off) of the $9,000 you lost.

$3,000 of this loss can be used to offset any kind of taxable income in a given year, the balance can offset capital gains, and any left over losses can be carried forward forever. Not only does the charitable recipient take this money tax-free, but the donor also receives a $1,000 charitable tax deduction in addition to the $9,000 capital loss deduction.

On the other hand, if you donate that same $1,000 worth of stock, you forfeit the $9,000 write off. Clearly, it is wiser to sell the depreciated stock and give the proceeds to charity.

Transferring Stock to Heirs

Another point to consider is that the basis “step-up” at death becomes a “step-down” when the stock is worth less at the time of your death than you originally paid for it. People who own depreciated property but are ailing will do better to give the property to their children or grandchildren while still living. This keeps the higher basis the donor has in the property, and if some gift tax has to be paid, that, too, will be out of the owner’s estate. This reduces future estate and income tax burdens on the recipient.

Consider someone who purchased stock for $10,000 last year that is now worth only $1,000. If the stock were inherited by the owner’s children or grandchildren at its current low market price, its basis would step-down to $1,000. In this case, if the stock later rebounded to a value of $10,500, the heirs will have $9,500 of capital gain on which they must pay tax, even though their parent or grandparent paid $10,000 for the stock!

If instead the parent or grandparent had given the heirs the property during his/her lifetime, the basis would be $10,000, and the future sale would produce only $500 of gain; indeed, if the heirs could not wait for the stock to come back up in price, they could sell it at the $1,000 price and get an immediate $9,000 capital loss deduction as described in the first example.

In short, when the market drops, there are still opportunities to take advantage of tax breaks when making gifts to family and charity alike.

For more news, return to the Estate Planning News subject index.

Originally posted April 2001. The information in this article reflects tax laws

at the time of posting. Relevant tax laws may change.