Donating appreciated assets to charity can be a shrewd tactic during your lifetime but such donations are not recommended in your estate plan. The change is due to the basis step-up rules.
Suppose John Smith bought mutual fund shares years ago for $5,000. At his death, those share are worth $20,000.
John might leave those shares to his daughter Kim. Assuming current law is still in effect, Kim’s cost basis in the shares would be stepped up to their market value of $20,000. Kim could sell the shares for $20,000 and owe no income tax, so the capital gains tax obligation would disappear.
Instead of appreciated assets, John might make charitable bequests from his traditional IRA. A traditional IRA gets no basis step-up at death. If John leaves a $20,000 traditional IRA to Kim, she’ll owe income tax on all withdrawals from that IRA. Assuming that Kim’s income tax rate is 35%, a $20,000 IRA that she inherits is really worth only $13,000, after tax.
Therefore, John should consider leaving his $20,000 IRA to charity because the charity won’t owe tax on the withdrawals. John’s appreciated assets can pass to Kim, who will get a basis step-up and avoid tax on capital gains during his lifetime.
