Benefits of Donating Private Equity Fund Interests to Charity
by the Charitable Strategies Group at Schwab Charitable
Donations of private equity fund interests held more than one year may provide a unique opportunity to leverage one of your most valuable investments to achieve maximum impact with your charitable giving.
Private equity funds often accrue significant value over time, which may generate large capital gains taxes when fund distributions are made. If you itemize deductions on your tax return instead of taking the standard deduction, donating your interest can unlock additional funds for charity in two ways. First, you potentially eliminate the capital gains tax you would incur if you sold the interest yourself and donated the proceeds, which may increase the amount available for charity by up to 20%. Second, you may claim a fair market value charitable deduction for the tax year in which the gift is made and may choose to pass on that savings in the form of more giving.
Donor-advised funds, which are 501(c)(3) public charities, provide an excellent gifting option for donations of private equity fund interests, as the funds typically have the resources and expertise for evaluating, receiving, processing, and liquidating this type of gift. How does gifting these interests to a donor-advised fund work?
Please be aware that gifts of appreciated non-cash assets can involve complicated tax analysis and advanced planning. This article is only intended to be a general overview of some donation considerations and is not intended to provide tax or legal guidance. In addition, all gifts to donor-advised funds are irrevocable. Please consult with your tax or legal advisor.
Case study: making a larger gift while increasing tax savings
To illustrate the benefits of donating long-term held and appreciated private equity fund interests, consider the case of Bob, an entrepreneur. He recently retired and now wants to dedicate his time and money to supporting his favorite charities. Bob meets with his advisor to identify portfolio holdings he can utilize to fund his philanthropic and legacy plans. In the meeting, Bob is surprised to learn he might be able to donate his limited partnership interests in two private equity funds, both of which have recently completed the investment stage and will soon realize and distribute gains.
Working with his advisor, Bob identifies an interest held more than one year with a fair market value of $3 million and adjusted cost basis of $250,000. Assuming a 20% federal capital gains tax rate based on Bob’s retirement income level, if he sold his interest he would realize appreciation or capital gains of $2,750,000 and owe an estimated $550,000 in federal capital gains taxes ($2,750,000 x 20% = $550,000).
In this scenario, as shown in Option 1, after paying the federal capital gains taxes, Bob’s estimated net cash available for charitable giving is $2,450,000.
In Option 2, Bob decides to donate the interest to a donor-advised fund that is willing to accept this type of asset and hold it until termination. With proper approvals from the private equity fund’s general partners and from the donor-advised fund, Bob’s advisor coordinates the transfer of ownership to the donor-advised fund. In this scenario, Bob may be able to eliminate capital gains taxes ($550,000) while potentially taking a current year income tax deduction based on the fair market value of his interest ($3,000,000), assuming he itemizes his deductions.
This hypothetical example is only for illustrative purposes. The example does not take into account any state or local taxes or the Medicare net investment income surtax. The tax savings shown is the tax deduction, multiplied by the donor’s income tax rate (37% in this example), minus the long-term capital gains taxes paid.
In addition to the potential tax benefits described above, the following considerations may apply.
1. Equity fund transfers are complex and require proper approvals.
Private equity fund general partners typically oversee transferability of fund shares. Limited partners who wish to donate a portion of their investment(s) to charity should work with the general partner to achieve this goal.
In some cases, general partners have established charitable giving programs to enable their investors to achieve their philanthropic goals by permitting charitable transfers of partnership interests or distribution of portfolio company stock prior to a sale. Such programs require active involvement of the fund’s general partner, may be complex, and can take time to establish. As such, initiating donation discussions well in advance of a liquidity event is critical.
Note also that the donor-advised fund or other public charity will generally not assume liabilities associated with these investments. You should plan to contribute sufficient non-cash assets to cover your grant recommendations as well as the private equity fund’s open commitments, unrelated business income tax, and other liabilities.
2. Appraisal requirement and annual deduction limits apply.
Overall deductions for donations to donor-advised funds are generally limited to 50% of your adjusted gross income (AGI). The limit increases to 60% of AGI for cash gifts, while the limit on donating appreciated non-cash assets held more than one year is 30% of AGI. The IRS permits a carryover for five tax years, should your charitable deduction exceed AGI limits in a given tax year.
Your fair market value tax deduction will be determined by a qualified appraisal of the contributed interest as of the date of transfer to the donor-advised fund or other public charity. In order to realize the full value of the investment, the charity must normally be able to hold the interest until the scheduled termination date or liquidity event. Sales of these interests in the secondary marketplace prior to this may be subject to steep discounts. In addition, if the private equity fund carries debt, you may be liable for taxes if the contribution is treated as a bargain sale.
Interested in learning more?
The Charitable Strategies Group at Schwab Charitable is a team of professionals with specialized knowledge about non-cash asset contributions to charities. Our team stands ready to support you and your advisors, from initial consultation through asset evaluation, receipt, processing, and sale. We strive to provide unbiased guidance and frequent communication at every step of the process to help you and your advisors make informed decisions and stay aware of the time required for your transaction.
If you would like to learn more about Schwab Charitable donor-advised fund accounts, click here.