As we reach the end of 2017, many people take the opportunity to review their charitable commitments for the year. While much time is given to determining the allocation of funds, people often overlook the true cost of making a donation.
At first blush, making a charitable donation may seem like a larger cash outlay than it actually is. People often forget that when you make a charitable donation you are entitled to receive a tax-credit from the government as a result of your gift. This credit ultimately benefits you when filing your personal tax-return, as the credit reduces your taxes payable balance owing to the CRA.
Many articles have been written at length about using “in-kind” donations of property to give a more tax efficient gift. It is common knowledge that in-kind donations of property, such as publicly traded shares or mutual funds, afford donors both a charitable tax receipt for the full market value of the investment and the opportunity to avoid paying taxes on the imbedded gains in the gifted security. Making gifts using this strategy has been a “no-brainer” for advisors and investors alike.
However, these articles typically fall short in that they fail to guide donors through the next step: “Which securities are best to donate?”. The answer is simple, donors should seek out the security with the largest capital gain to optimize their donation. The larger the imbedded capital gain in an investment, the more benefit to be derived by avoiding the tax on the imbedded gain through an “in-kind” donation.
Certain mutual funds that pay a return of capital (“ROC”) distribution can present the perfect solution for clients looking for a way to make the most efficient donation. Return of capital is a distribution from a mutual fund that draws its tax-free character from the adjusted cost basis (“ACB”) of the investment. As an investor receives ROC distributions they simultaneously grind down (reduce) the ACB of their investment until it reaches $1, at which point, any additional ROC distributions are taxed as a capital gain. Investors holding ROC mutual funds with an ACB of $1 in fact have the most efficient securities to donate. Below are 3 examples of donating $10,000 to a registered charity to illustrate the benefit.
As you could see from the above example, an in-kind donation is clearly a more efficient way to donate as compared to traditional gifts of cash. However, in order to truly make the most efficient donation possible, donors should seek out the security with the largest imbedded capital gain to donate. A mutual fund that pays a ROC distribution can help investors create a security “ripe for donating”.
This year, when thinking about how much you can afford to give toward charitable causes, remember the true cost of making your gift, it can be significantly less than what you initially thought.