Donor-Advised Funds

A Donor-Advised Fund (DAF) is a charitable giving account that allows one to donate cash or securities to the account and take an immediate contribution deduction on their taxes as an itemized deduction. The benefit is that you then have flexibility in when to grant the money to charities (eligible 501(c)(3) organizations) of your choice, even across multiple years. However, the donation is irrevocable and cannot be returned to you once contributed.

These accounts also offer various investment options for investing the donated cash/securities. Some providers will allow you to invest freely, while others will limit you to a certain mix of mutual funds depending on the balance of your DAF. Since this is a special account designed for charitable purposes, selling securities in your account will not result in taxable income.

The deduction is limited to the standard charitable deduction rules. Cash donations are deductible up to 60% of your AGI. Stocks with short-term capital gains (STCG) are deductible up to 50% of your AGI, but you only receive a deduction based on your cost basis. For example, if the STCG stock you’re donating is worth $30k, but your cost basis is $25k, you will receive a deduction of $25k. Finally, stocks with long-term capital gains (LTCG) are deductible up to 30% of your AGI, but you receive a deduction based on the stock’s current market value. In the prior example, you would receive a deduction of $30k.

Since stock with LTCG can be deducted for the current market value (subject to AGI caps), donating LTCG stock with a low cost basis to your DAF is preferable to be as tax-efficient as possible. For individuals with charitable intent, this can be a fantastic strategy for diversifying out of concentrated stock positions with significant unrealized gains.

With reasoning similar to diversifying concentrated stock, this strategy also works well with direct indexing. Direct indexing is where you own (or a portion of) the underlying stocks representing an index, say the S&P 500, in a single brokerage account. You sell securities with unrealized losses and purchase different positions. Your total exposure should continuously mimic the index, providing a similar return with a reasonable tracking error. Direct indexing over time causes you to have more stocks with low cost basis and high unrealized capital gains. Finally, you donate the highest appreciated lots (lowest relative cost basis) to a DAF to reduce the overall unrealized gain in the account.

Tax Planning Item for 2025 before OBBBA Kicks in for 2026

The One Big Beautiful Bill Act of 2025 introduces a new 0.5% AGI floor for charitable contributions that begins in 2026. The first 0.5% of charitable donations will be excluded from itemized deductions. Say your AGI is $500k and you donate $10,000 in cash. You will receive $7,500 in itemized deductions, as 0.5% of $500k is $2.5k, which is excluded.

Therefore, utilizing a DAF could be a great planning opportunity before 2025 ends to front-load charitable contributions before the new AGI floor begins in 2026.

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