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How to Avoid Capital Gains Taxes

How to Avoid Capital Gains Taxes

Capital gains taxes can take a major bite out of your investment earnings if you don’t manage your portfolio specifically for them. The strategies that allow you to minimize the capital gains tax include holding investments for the long term, using tax-deferred accounts and more. By becoming a tax-conscious investor, you can maximize your long-term returns for retirement or other financial goals. You may also want to consult with a financial advisor about your overall tax situation.

What Are Capital Gains Taxes?

When you own an investment or other asset – such as real estate, land, a business or stocks, for example – and later sell that asset for a profit, you have realized capital gains. The capital gains tax, which is most notable at the federal level, is then placed on the profit portion of your returns.

Depending on how your gains are classified and your total taxable income for the year, your capital gains tax rate can vary. This percentage could be as low as 0% or as high as your ordinary tax rate. The long-term rates (investments held at least a year) are where you’ll get by far the most favorable tax treatment. On the other hand, investments you sell sooner than that are taxed at normal income tax rates, which can get quite high.

Here’s a breakdown of the long-term capital gains tax rates for the 2022 tax year (which you’ll file in 2023):

Federal Tax Rates for Long-Term Capital Gains

RateSingleMarried Filing JointlyMarried Filing SeparatelyHead of Household
0%$0 – $41,675$0 – $83,350$0 – $41,675$0 – $55,800
15%$41,676 – $459,750$83,351 – $517,200$41,676 – $258,600$55,801 – $488,500

Conversely, these are the income tax rates for the 2022 tax year, and you’ll notice they’re much steeper:

Federal Ordinary Income Tax Rates for Short-Term Capital Gains

RateSingleMarried Filing JointlyMarried Filing SeparatelyHead of Household
10%$0 – $10,275$0 – $20,550$0 – $10,275$0 – $14,650
12%$10,276 – $41,775$20,551 – $83,550$10,276 – $41,775$14,651 – $55,901
22%$41,776 – $89,075$83,551 – $178,150$41,776 – $89,075$55,901 – $89,050
24%$89,076 – $170,050$178,151 – $340,100$89,076 – $170,050$89,051 – $170,050
32%$170,051 – $215,950$340,101 – $431,900$170,051 – $215,950$170,051 – $215,950
35%$215,951 – $539,900$431,901 – $647,850$215,951 – $323,295$215,951 – $539,900

How to Avoid Capital Gains Taxes

Handing over a chunk of your profit can be painful. Thankfully, there are a few ways that you can reduce the amount of capital gains taxes you will pay after selling an asset.

Choose Long-Term Investments

Capital gains can be classified as either short-term or long-term, each of which has its own tax rates.

Assets that you have held for less than a year are considered short-term. When it comes to earning short-term gains, expect to be taxed at your ordinary tax rate … which can be as high as 37%, depending on your total taxable income.

If you want to avoid that, you should choose long-term investments instead. By holding an investment for a year or more, you will qualify for long-term capital gains tax rates.

Most long-term capital gains will see a tax rate of no more than 15%, though certain assets (like coins and art) can be taxed at a rate up to 28%. Depending on your income, you may even qualify for capital gains tax rates as low as 0%.

Take Advantage of Tax-Deferred Retirement Accounts

How to Avoid Capital Gains Taxes

Your retirement accounts likely make up a bulk of your savings and future assets. It’s wise to optimize these as best you can by utilizing tax-deferred (and tax-exempt) plans, to save yourself from added capital gains taxes. When contributing to a tax-deferred retirement plan, such as a 401(k) or traditional IRA, you’ll receive a tax deduction on your contributions in the current tax year. This can save you money on your income taxes today, as well as help you to save even more toward the future.

Your money will also continue to grow over time. When you’re finally ready to sell your investments and withdraw, any growth in the account is taxed at your ordinary income rate, rather than being subject to capital gains like other investment accounts.

A tax-exempt account, such as a Roth IRA, doesn’t offer any tax benefits today. However, the money held in this account will grow tax-free until retirement. When you’re ready to use the money, your funds (and growth) can also be withdrawn tax-free, helping you avoid capital gains yet again.

Offset Your Gains With Losses

If you hold a number of different assets, you may be able to offset some of your gains with any applicable losses, allowing you to avoid a portion of your capital gains taxes.

For instance, if you have one investment that is down by $3,000 and another that is up by $5,000, selling both will help you reduce your gains. You would only be subject to capital gains taxes on the difference – or $2,000 – rather than the full $5,000 gain of the second investment.

Another offset strategy is tax-loss harvesting. With this method, you can carry over losses from one tax year into the next, to help offset future gains. Tax loss harvesting only applies if your losses in a given year exceed your total gains.

Bottom Line

How to Avoid Capital Gains Taxes

Reducing the capital gains taxes you pay on certain assets can keep more of your money in your own pocket. Capital gains taxes can range from 0% to 28%, depending on factors such as your income and the asset itself. Offsets, tax-advantaged retirement accounts and long-term investments may each be worth considering when developing a strong tax strategy.

Tips on Taxes

  • Consider working with a financial advisor to ensure that you’re not paying a penny more than you need so. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Income in America is taxed by the federal government, most state governments and many local governments. The federal income tax system is progressive, so the rate of taxation increases as income increases. Use SmartAsset’s free income tax calculator to get a quick estimate of what you owe.

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