Capital gains taxes are a tax on the profits you make on investments, which you might owe if you are investing through a taxable brokerage account. The good news is that there are strategies investors can use to eliminate or minimize those taxes. The right ways for you will depend on your long-term financial goals. If you’re not sure what path to take to avoid taxes you can work with a professional financial advisor who can help you create a financial plan and provide the right ways to avoid these taxes.
What Are Capital Gains Taxes?
Capital gains taxes are taxes owed when you sell an asset for a profit. The tax rates vary depending on how long you held the stocks. If you sell it for a loss, you do not owe any taxes on that transaction. So a capital gain on a stock you own would be the profit you receive that is above what you originally paid for those stocks.
For example, if you bought one share of XYZ Corporation at $10 and end up selling it for $100, your capital gain would be taxed on the $90 difference. How long you hold that asset will depend on where it is a long- or short-term gain. There is a difference when determining how those taxes are treated and the rate at which you’ll have to pay.
- Short-term capital gains: When you’ve held the stock for one year or less, these are called short-term capital gains. Short-term capital gains tax rates have the same income tax rates as ordinary income, like the money earned from a job.
- Long-term capital gains: Long-term capital gains offer preferential treatment in the Federal tax code. These income tax rates are lower than ordinary income tax rates with a maximum tax rate of 20%. In some cases, long-term capital gains tax rates can be as low as 0%.
How Capital Gains Are Taxed on Stocks
The tax rates for the capital gains you earn on your stocks are going to be determined by both your tax filing status as well as your adjusted gross income (AGI). You will end up being taxed between 0% and 20% of your profit, depending on your filing status. You will likely end up paying either 15% if your AGI is between $44,626 and $492,300 as a single filer or $89,251 and $553,850 as a married couple filing together. For individuals above $492,300 and couples over $553,850, the rate will be 20%.
In addition to the capital gains tax, high-net-worth individuals or high-earners might end up being on the hook for additional taxes for their investment profits. The net investment income tax can add an additional 3.8% tax on top of your capital gains tax if your modified adjusted gross income (MAGI) is above $200,000 for single filers or $250,000 for married filing jointly.
9 Ways to Avoid Capital Gains Taxes on Stocks
There are numerous strategies that investors can implement to reduce or avoid capital gains tax on stocks sold at a profit. Each has its own unique pros and cons that you should take a look at to see if it’s a good fit for your personal situation before moving forward.
Here are some of the most common methods that you can incorporate into your financial plan:
1. Invest for the Long Term
When you invest for the long term, you benefit from long-term capital gains rates. These tax rates can be substantially lower than ordinary income tax rates. In 2023, if your taxable income is less than $44,625 as a single filer ($89,250 for married, filing jointly), your long-term capital gains tax rate is 0%.
2. Contribute to Your Retirement Accounts
Investing in retirement accounts eliminates capital gains taxes on your portfolio. You can buy and sell stocks, bonds and other assets without triggering capital gains taxes. Withdrawals from Traditional IRA, 401(k) and similar accounts may lead to ordinary income taxes. However, Roth accounts eliminate taxes entirely on eligible withdrawals.
3. Pick Your Cost Basis
When selling your stocks, it is possible to pick your cost basis on the shares that you sell. By handpicking the individual shares, you may be able to avoid capital gains taxes by selling shares that are at a loss (or at least have lower gains), even if your overall position in that investment has made money.
4. Lower Your Tax Bracket
When you have less taxable income, you may qualify for 0% tax rates on long-term capital gains. You can lower your taxable income by being strategic on withdrawals. For example, retirees can make withdrawals from a Roth IRA instead of a 401(k) or traditional IRA, since Roth withdrawals are not taxable in retirement.
Alternatively, you can maximize your deductions by prepaying property tax payments before December 31 or bunching two year’s worth of charitable contributions into one year. Another option to keep from getting bumped up into a higher tax bracket is deferring income and maximizing your deductions. Maxing out your company retirement accounts and health savings accounts (HSA) is an excellent way to reduce your taxable income as well.
5. Harvest Losses to Offset Gains
Capital losses on investments can offset realized short-term and long-term capital gains. Some investors harvest losses proactively when investments go down in value to offset potential future capital gains. Investors may also offset $3,000 in ordinary income yearly if they have excess capital losses.
6. Move to a Tax-Friendly State
While the state you live in won’t affect your federal taxes owed, moving to a tax-friendly state may help you avoid capital gains tax on stocks when paying state income taxes. Nine states do not charge capital gains taxes. The states are Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming.
7. Donate Stock to Charity
If you have appreciated stock, consider donating the stock instead of cash to your favorite charity. You won’t owe capital gains taxes on the profits when you transfer those shares directly to the charity. Plus, you’ll get a tax deduction based on the current value of the shares instead of the actual amount that you paid for them. And the charity won’t owe taxes either, making it a win-win for both parties.
8. Invest in an Opportunity Zone
The Tax Cuts and Jobs Act created “opportunity zones” that offer tax advantages to investors. By investing in eligible low-income and distressed communities, you can defer taxes and potentially avoid capital gains tax on stocks altogether. To qualify, you must invest unrealized gains within 180 days of a stock sale into an eligible opportunity fund, then hold the investment for at least 10 years.
9. Pass Down Appreciated Assets
When someone passes away, there is a step-up in the cost basis of their assets. This means that the heirs that receive stocks, bonds, real estate and other assets do not owe capital gains taxes if they sell the assets right away. If the assets continue to appreciate after the investor’s death, the beneficiaries will only owe taxes on the appreciation that occurred after their date of death.
Capital gains taxes can negatively impact your investment profits, especially if you’ve held the assets for one year or less. Luckily, there are numerous strategies that investors can use to reduce or avoid capital gains tax on stocks, bonds and other assets. Before making any moves, talk with a financial planner or tax advisor to discuss your current situation and the strategies that you’re considering.
Tips for Tax Planning
- Investors with a financial advisor can work together to reduce or avoid capital gains tax on stocks and other investments. By using their experience and knowledge, a financial advisor can propose steps to minimize the taxes you’ll owe on your stock sales. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Capital gains taxes reduce the profits that you’ve earned from your investments. You can properly plan out what your potential liability might be by planning ahead for how your investments might grow. Use our investment calculator to know what your potential increase might be.
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