# 20

The United States has a strange (legal) tax loophole where you can double-count capital gains when donating securies (with some restrictions): If you buy a stock, the values goes up, and you've held it for at least a year, you can donate it and claim a tax deduction on the current market value instead of the value of what you paid for it (the cost basis), and you don't pay taxes on the gains.

To see why this is a loophole, take a year where you make \$100,000 in income and bought a stock for \$15,000 last year and donated it this year (after holding it for at least a year).

• If the stock's price didn't change, the market value of the stock is \$15,000 and you reduce your taxable income to \$85,000
• If the stock doubles in price, the market value is now \$30,000 and you reduce your taxable income to \$70,000[1]

Notice that you're donating exactly the same thing: You paid \$15,000 on Jan 1st and everything that happened after that is irrelevant to you (except for the warm-fuzzies I guess).

If you could find two perfectly anti-correlated securities, you could exploit this more:

1. Buy \$7,500 of security A and \$7,500 of security B
2. Wait a year
3. Sell whichever security went down and donate the proceeds, along with the security that went up
4. Deduct the charitable donations (at least \$15,000)
5. Deduct the loss on the security that went down

As an extreme case, if you found one security that doubles and one that goes to \$0, you would have \$15,000 in charity donations plus \$7,500 in losses.[2]

Anyway, I'm wondering why people don't exploit this? Tax avoidance is as legal as shooting an apple pie as long as you follow the letter of the law[3] so I feel like I must be missing something.

I imagine "find two perfectly anti-correlated security with huge variance" is hard, but they don't have to be perfect for this strategy to be worth it. It seems like if you can find a charity that will accept options (like this one), you could do a long straddle and donate the in-the-money side, although this would be complicated and I think only 60% of the gains could be double-counted[4]. Needing to hold whatever securities for a year is also annoying, but that's not a particularly long amount of time in the grand scheme of things.

Note: Please don't blindly take this question as an argument that you should do this. If you actually plan to do this, you should really talk to someone who knows what they're doing first, and make sure the charity you plan to donate to will accept whatever security you want to give them. Tax avoidance is legal, but you there is a rulebook and you really must follow the proper rituals precisely.

1. You could imagine more extreme cases, like the price going up by 10x and reducing your taxable income to \$0, but you can only exploit this for up to 30% of your income (although you might be able to carry the excess forward?). ↩︎

2. There's really no limit to this. If you found a security that goes up by 10x, you could claim \$75,000 in charitable donations plus whatever losses on the other side. ↩︎

3. Look up "Mega Backdoor Roth" if you don't believe me. ↩︎

4. According to the info on Form 6781, "Under these rules, each [side of the straddle] held at year end is treated as if it were sold at fair market value (FMV) on the last business day of the tax year." and "If [the relevant options] produce capital gain or loss, gains or losses on [those options] open at the end of the year, or terminated during the year, are treated as 60% long term and 40% short term, regardless of how long the contracts were held." I think you could still exploit this by starting your straddle on Dec 31st of year 1 and donating/selling it on Dec 31st of year 2, although only the 60% long-term gains get double-counted. ↩︎

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# 3 Answers sorted by top scoring

Austin Chen

### Mar 03, 2024

80

My friend Eric once proposed something similar, except where two charitable individuals just create the security directly. Say Alice and Bob both want to donate \$7500 to Givewell; instead of doing so directly, they could create a security which is "flip a coin, winner gets \$15000". They do so, Alice wins, waits a year and donates for \$15000 of appreciated longterm gains and gets a tax deduction, while Bob deducts the \$7500 loss.

This seems to me like it ought to work, but I've never actually tried this myself...

bhauth

### Mar 03, 2024

70

Anyway, I'm wondering why people don't exploit this?

I think people usually do this with art instead of stocks.

That actually would explain a lot about art values.

PeterMcCluskey

### Mar 03, 2024

62

The part about "securities with huge variance" is somewhat widely used. See how much EA charities get from crypto and tech startup stock donations.

It's unclear whether the perfectly anti-correlated pair improves this kind of strategy. I guess you're trying to make the strategy more appealing to risk-averse investors? That sounds like it maybe should work, but is hard because risk-averse investors don't want to be early adopters of a new strategy?