Michael S. Schwartz, CFP®, AEP®
I apply a multidisciplinary approach to wealth management dovetailed with structured tax planning.
It was valued at $30 million per foot. That is a big price tag, considering it stood only 3 feet tall. The sale, however, created an even taller problem—taxes.
A 2019 Bloomberg article reported that Steven A. Cohen, founder of Point72 Asset Management, paid $91 million for artist Jeff Koons’ creation Rabbit—a shiny stainless-steel sculpture that looks like a balloon bunny. At $91 million, it is no surprise that the hedge fund manager set a record for the highest price ever paid for a living artist’s work. While he purchased a pop-art sculpture, the seller, the estate of the late magazine publisher S. I. Newhouse, likely received a hefty tax bill. If so, could advanced financial planning have allowed the seller to make the sale, keep the proceeds and distribute tax-free income to itself? It is like asking to pull a financial rabbit out of a hat. That is, unless the seller enlisted another work of art—the donor advised fund (DAF)—to help.
What Is A DAF?
Financial planners have many tools at their disposal, but the DAF is one of the more donor-friendly planned giving vehicles. A DAF is administered by a public charity, but you can think of it as a charitable savings account. The accounts are controlled by a nonprofit organization, which is called the sponsoring organization. You can find anything from small community organizations to large financial firms, such as Vanguard Charitable, Fidelity Charitable or National Philanthropic Trust (NPT), to serve as sponsors.
You simply open an account and contribute cash, stocks, bonds or other financial assets and can immediately claim the maximum charitable tax benefits allowed. While some sponsors have no minimums, most have minimums starting as low as $5,000. Once the money is donated, you surrender ownership—it is an irrevocable gift.
However, you do get advisory privileges, which means you can choose who gets the money and can recommend grants and allocations. You can also donate today for tax breaks but be sure to take time to decide where the money will go. There is a caveat: The sponsoring organization has ultimate control over the assets, so while you can make recommendations, it is not obligated to follow them. Most organizations will consider your wishes, though.
Donations are not just limited to financial assets. Non-cash assets like real estate—and art—can also be donated. By IRS rules, artwork owned by a collector or inherited and held for more than one year that has appreciated in value qualifies as a collectible. When you sell a collectible, capital gains taxes are usually owed on the difference between the current fair market value and the owner’s cost basis, but this is where a DAF can help.
Art is considered tangible personal property, and without additional financial planning, limits the charitable deduction to its cost basis, but if it is donated to a DAF, your tax deduction is based on the fair market value. A DAF allows you to make donations in the current year that otherwise would exceed your standard deduction. You can make large donations today, take the full deductions and still instruct your DAF to grant money to your favorite charities over time.
NPT’s 2019 DAF annual report outlined a number of key points that highlight the rise in popularity of donor-advised funds and their utilization. The report notes that in 2018, DAF contributions surpassed $37 billion, an increase of 86% over five years, and DAF contributions accounted for 12.7% of total individual giving.
To see the benefits, I will illustrate a hypothetical sale below. In our example, the Koons’ Bunny seller has a cost basis of $1,000,000 and donates the artwork to a DAF prior to the sale. The 65-year-old donor is unmarried with one adult child 29 years of age. As noted above, because art is considered tangible personal property, the charitable deduction (without additional planning) would be limited to its cost basis ($1 million). The trustee of the DAF could then sell the sculpture post-gift for $91 million, and all capital gains would be eliminated. The net sales proceeds could be reinvested into a portfolio of marketable securities. If both the donor and child lived to age 85, and assuming a 5% net rate of return, the planning could provide the following profound benefits:
• Capital gains tax savings: a little over $25 million ($90 million x 28% capital gains tax)
• Distributions to charity: approximately $232 million, $2.5 million per year over the donor’s life and $5 million per year for the second generation (Note: The charity figures and exact totals are based on a complex formula.)
• Remainder to charity: approximately $424 million
A DAF can be a powerful giving vehicle and income tax planning tool. They have gained popularity for several reasons, including their tax advantages, flexibility and ease of administration. They allow you to donate cash or highly appreciated assets and receive a meaningful charitable deduction, which can be used to offset taxable income in the year of donation and up to five additional years for any unused deduction. The deduction can be used to convert an individual retirement account (IRA) into a Roth IRA tax-free, which removes the taxation on the IRA at the time of distribution. Best of all, they can empower a donor and their family to create a charitable legacy, which can be facilitated over one or more generations, fund an unlimited number of IRS-qualified public charities and provide full control over the timing of all gifts.
With a DAF, a charitable legacy may just be a hop, skip and jump away.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.