When Realizing Capital Gains Reduces Tax

This is not tax advice. My relevant training is in reading, writing, and arithmetic.

Reading this post is much more likely to be fun[1] than useful, but if you donate more than you can deduct from your US taxes, it might save you a few hundred dollars.

If you own appreciated stocks and want to donate to a charity, you have a choice between the following options:

  1. Donate the stocks directly to a charity[2]

  2. Sell the stocks and donate the cash

These two options have different tax implications. There are several posts that discuss tax optimization for large donors in the United States.[3][4][5][6] These posts are helpful and good and recommend donating the stocks directly. This is usually correct because

  1. Selling the stocks will cause you to owe tax on the realized gains

  2. Avoiding capital gains will allow you to deduct up to $3k of capital losses from your taxable income[7]

However, there is[8] a quirk[9] of the tax system such that you can sometimes end up owing less tax by realizing more long-term capital gains.[10][11]

The amount of your charitable contributions that you can deduct from your federal taxes is limited to a certain percentage of your AGI.[12] The highest limit is 60% of AGI for cash donations.[13] If you’ve already donated cash in excess of the 60% limit[14], then a marginal dollar of AGI increases your charitable deduction by 60 cents. Long-term capital gains are included in AGI but taxed at a lower rate than ordinary income.[15] So realizing capital gains has two counteracting effects:

  1. Creating a tax liability on the capital gains themselves

  2. Decreasing your income tax liability by increasing your deductions

If the latter outweighs the former, then you effectively face a negative marginal tax on long-term capital gains. If you donate cash in excess of the 60% limit and don’t have capital losses, this can happen in real life.

Federal-Only Examples

Suppose you’re a single filer and your 2024 ordinary income was $750k and you donated $600k of that to a public charity and do not have any capital losses. You can deduct $450k, 60% of your AGI, which puts your taxable income at $300k. This is in the 35% income tax bracket and the 15% capital gains tax bracket.[16] Additionally, because your AGI exceeds $200k, your marginal capital gains are subject to the 3.8% net investment income tax.[17] You are not subject to the alternative minimum tax because the alternative minimum tax calculation still allows subtracting charitable donations. A marginal dollar of AGI lets you deduct an additional 60 cents from your taxable income. Putting all of this together gives you an effective marginal long-term capital gains tax rate of . That is, realizing $1000 of long-term capital gains would reduce the amount of tax you owe by $22.[10] If you’re in the 32% federal income tax bracket, this still works out slightly favorable: . Putting some test numbers into FreeTaxUSA’s filing software gives outputs consistent with the above calculations. If you live in a state that doesn’t tax wages or capital gains[18], then that’s all there is to it.

Illinois Examples

Illinois imposes a 4.95% flat tax on wages and capital gains and does not allow deductions for charitable donations. This only works out to a negative combined rate if you’re in the 0% capital gains bracket. Suppose you’re a single filer with $85k of ordinary income and $60k of cash donations. This puts your taxable income in the 12% income tax bracket and the 0% capital gains tax bracket.[16] You are not subject to the net investment income tax.[17] A marginal dollar of AGI lets you deduct an additional 60 cents for your donations and increases your Illinois tax liability by 4.95 cents. The additional state tax is deductible from your federal taxable income. So your effective marginal rate on the capital gains is .

I have not checked the state-level results against the output of tax preparation software or state tax authorities’ worksheets, so these calculations are much more likely to be wrong than the federal-only ones.

California Examples

California has a progressive income tax system and taxes capital gains as ordinary income.[19] Suppose you’re a single filer with $135k of ordinary income and $95k of cash donations. This puts your federal taxable income in the 22% income tax bracket and 15% capital gains tax bracket.[16] And your California taxable income in the 9.3% bracket. [20] Charitable donations are deductible from your California taxes, but California limits the deduction to 50% of your federal AGI.[21] This means your effective marginal California tax on capital gains is , which happens to be close to the Illinois tax rate. This gives a combined rate of , so in this case, you’re better of donating the stocks directly. If you’re, instead, in the 32% federal tax bracket, you can’t use that same formula because of the $10k limit on deductions for state and local income tax; Someone with a high enough income to be in the 32% federal bracket would owe more than $10k of California tax and be unable to deduct marginal state taxes[22] and also be subject to the 3.8% net investment income tax.[17] So you end up with , which still favors donating directly. So, as with Illinois, realizing the capital gains only works out to being favorable if you’re in the 0% capital gains bracket. If you’re in the 0% federal capital gains bracket and the 6% California bracket, your effective marginal capital gains tax rate would look like .

  1. ^

    If you don’t find reading about taxes fun, you won’t enjoy reading this post and probably shouldn’t’ve clicked on it. Sorry.

  2. ^

    The only charity you directly give stocks to should be a donor-advised fund, otherwise people at (e.g.) GiveWell have to deal with stock-related paperwork.

  3. ^
  4. ^
  5. ^

    https://​​reducing-suffering.org/​​advanced-tips-on-personal-finance/​​ (The “Negative capital-gains tax” section is not the same thing as the negative capital gains tax that this post is about)

  6. ^
  7. ^

    If you have capital losses and capital gains, they offset each other. But capital losses that do not offset capital gains can offset up to $3k per year of ordinary income. Since ordinary income is taxed at a higher rate than long-term capital gains, it’s advantageous to donate the stocks for this reason. This capital loss deduction probably amounts to more tax savings than the effect that this post is about and is, therefore, more relevant to investment decisions. A relevant search term is “tax loss harvesting”.

  8. ^

    as far as i can tell

  9. ^

    If i were an author of the US tax code, i would call this a “bug”.

  10. ^

    Also, there could be an advantage to donating cash instead of appreciated stocks because that lets you deduct 60% of your AGI instead of 30%. But that’s not what this post is about.

  11. ^

    Qualified dividends are taxed at long-term capital gains rates, so this might also affect investment decisions.

  12. ^

    More accurately, the limit is proportional to your contribution base, which is defined (in 26 U.S. Code § 170 (b)(1)(H)) as equal to your adjusted gross income unless you have net operating loss carryback. I’m assuming that you don’t have net operating loss carryback.

  13. ^

    26 U.S. Code § 170 (b)(1)(G); This will change from 60% to 50% in tax year 2026. I’m assuming that it’s currently 2024.

  14. ^

    in this year or with carryover acquired by exceeding the limit in the previous five years

  15. ^

    that lower rate is sometimes zero

  16. ^
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  18. ^

    Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Wyoming

  19. ^
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