Confluent Asset Management capital gains article

Worried about capital gains taxes? We've got strategies to help!

Written by: Yogesh Prasad, CFA, CAIA

Capital gains tax can significantly impact on your investment returns. However, with careful planning and strategic decision-making, you can minimize your tax liability and keep more of your profits. Here are some effective strategies to help you avoid or reduce capital gains tax. 

Hold Investments for the Long Term

One of the simplest ways to minimize capital gains tax is to hold your investments for more than a year before selling. Long-term capital gains are taxed at lower rates compared to short-term gains.  

  • Short-term gains (assets held for 1 year or less) are taxed as ordinary income  
  • Long-term gains (assets held for more than 1 year) benefit from preferential tax rates, with a maximum rate of 20%

 

By adopting a long-term investment perspective, you can significantly reduce your tax burden. 

Utilize Tax-Advantaged Accounts

Investing through tax-advantaged accounts like 401(k)s, IRAs, and Roth IRAs can help you defer or even eliminate capital gains taxes.  

  • Traditional 401(k)s and IRAs: Investments grow tax-deferred, and you pay taxes only upon withdrawal  
  • Roth IRAs: Contributions are made with after-tax dollars, but qualified withdrawals are tax-free  

 

Strategically allocating your investments between taxable and tax-advantaged accounts can optimize your overall tax situation. 

Harvest Tax Losses

Tax-loss harvesting involves selling underperforming investments to offset gains from other investments. This strategy can help reduce your overall tax liability. For example, if you have $10,000 in capital gains and $8,000 in capital losses, your net taxable gain would be reduced to $2,000. 

Choose Your Cost Basis Method Wisely

When selling stocks, you can choose which specific shares to sell. By selecting shares with a higher cost basis, you can minimize your capital gains. Common cost basis methods include:  

  • First In, First Out (FIFO)  
  • Last In, First Out (LIFO)  
  • Specific Identification  

Consult with a tax professional to determine the most advantageous method for your situation. 

Lower Your Taxable Income

Reducing your overall taxable income can help you qualify for lower capital gains tax rates. Consider strategies such as:  

  • Maximizing contributions to retirement accounts  
  • Taking advantage of deductions and credits  
  • Deferring income to a later tax year 

Donate Appreciated Assets

Instead of selling appreciated stocks and donating cash, consider donating the stocks directly to charity. This strategy allows you to:  

  • Avoid capital gains tax on the appreciation 
  • Receive a tax deduction for the full market value of the donated stocks 

Invest in Opportunity Zones

Opportunity Zones offer tax advantages for investing in certain low-income communities. Benefits include:  

  • Deferral of capital gains taxes  
  • Potential reduction of the taxable amount  
  • Elimination of taxes on future appreciation if held for at least 10 years 

Use 1031 Exchanges for Real Estate

For real estate investors, 1031 exchanges allow you to defer capital gains taxes by reinvesting the proceeds from a property sale into another like-kind property. Consider Timing of Asset Sales Strategically timing your asset sales can help manage your tax liability. Consider:  

  • Selling in years when your overall income is lower  
  • Spreading large gains over multiple tax years  
  • Monitoring potential changes in tax laws 

Relocate to a Tax-Friendly State

If you’re open to relocating, consider moving to a state with no capital gains tax. States like Florida, Nevada, and Texas do not impose state-level capital gains taxes. 

Conclusion

Minimizing capital gains tax requires careful planning and a thorough understanding of tax laws. While these strategies can be effective, it’s crucial to consult with a qualified tax professional or financial advisor to develop a personalized plan that aligns with your specific financial situation and goals. Remember, tax laws are complex and subject to change. Stay informed and regularly review your investment strategy to ensure you’re maximizing your after-tax returns. 

Confluent Asset Management is a Registered Investment Adviser that offers institutional and individual investors systematic wealth and asset management services and investment solutions.

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