Mr. and Mrs. Smith are charitably inclined.  They typically donate about $10,000 per year by way of a donor-advised fund.   Each year the Smiths select about $10,000 of appreciated securities (those with long-term capital gains) from within their investment portfolio, which are subsequently moved in-kind (without liquidation) into their Donor-Advised Fund.   They receive an immediate tax deduction equal to the full fair market value of these positions, and they pay no capital gains tax on the sale of those positions once in the donor-advised account.  The Smiths subsequently recommend that the charitable custodian issue about $8,000 worth of grants to several of their favorite charities, including the American Cancer Society, a local food bank, and the ACLU.  The remaining $2,000 remains in the donor-advised fund and can be used for future grants – it need not be pushed out of the donor-advised fund prior to year-end (there is no “use it or lose it” provision).

The Smiths own their NYC apartment, which is worth about $1.3MM and has an $850K interest-only 4% mortgage outstanding.  They plan to retire in 2019, sell their NYC apartment, and relocate to South Carolina in order to be closer to their children and new grandchildren.  They will likely rent an apartment in SC for a year or so while they get to know the area and identify a new primary residence that they’d like to purchase.

Under the new tax law, the Smiths’ federal income tax return would include the following deductions:

 

2018

Mortgage interest deduction$     34,000
State and local taxes plus property taxes$     10,000
Charitable giving$     10,000
TOTAL$     54,000

 

Since the Smiths’ mortgage was put into place prior to 2018, they are still able to deduct interest on the full $850K principal balance (as opposed to being capped at $750K, which is the limit for loans obtained after 2017).  Although Mr. and Mrs. Smith are both high earners with significant state and local income tax burdens, under the 2018 tax law they are only able to deduct up to $10K for their state/local income taxes and property taxes combined.

Because the Smiths’ federal deductions total $54,000 which exceeds the new standard deduction for married couples filing jointly ($24,000), they will itemize their tax deductions in 2018.

By 2019, the Smiths are happily retired and find that they enjoy the flexibility of renting their home rather than owning it.  They remain charitably inclined and once again transfer $10,000 of appreciated securities into their donor-advised fund, most of which will be subsequently sent out to end charities of their choice.   For 2019, the Smiths’ federal income tax return would include the following deductions:

 

2019

Mortgage interest deduction$                –
State and local taxes plus property taxes$     10,000
Charitable giving$     10,000
TOTAL$     20,000

 

Because the Smiths’ federal deductions total $20,000, they will end up taking the standard deduction of $24,000, rather than itemizing their deductions individually.  In this way, they do not “get credit for” the full $10,000 that they have donated to charity – as they would have used the $24,000 standard deduction whether or not they made this gift.

A better course of action would have been for the Smiths to front-load their charitable giving in 2018, by making at least two years’ worth of charitable gifts at once.  Recall that because they are using a donor-advised fund, the gift funds will simply sit there (across multiple tax years) until the Smiths recommend outgoing grants.

In this way, the timing of the deduction (2018) is decoupled from the timing of the actual gift received by the end charities (both 2018 and 2019):

 

2018 – Revised

Mortgage interest deduction$     34,000
State and local taxes plus property taxes$     10,000
Charitable giving$     20,000
TOTAL$     64,000

 

In 2018, they will itemize $64K worth of deductions because they exceed the $24K standard deduction threshold – thus receiving a deduction for every dollar that has been gifted.

2019 – Revised

Mortgage interest deduction$             –
State and local taxes plus property taxes$     10,000
Charitable giving$             –
TOTAL$     10,000

 

In 2019, they will take the standard deduction of $24K, despite only having $10K worth of deductions.

The bottom line is this:  If you are charitably inclined and anticipate a change in your tax picture over the new few years, speak with your advisor in order to ensure that you are maximizing the tax impact of your gifts.

 

 

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Natalie Truty, CFP®

Natalie is a wealth advisor in our New York City office.