Avoid Capital Gains Tax

Capital gains (the money made from selling a non-inventory asset like stocks, bonds, property, and precious metals at a profit) are often taxed at fairly high rates — especially if you already have a high income. For instance, in the United States, people with very high incomes (over $400,000 for single, $450,000 for married filing jointly) can expect to pay a 20% capital gains tax. Many states add additional taxes on top of this base federal rate. Luckily, there are several ways to avoid some or even all of your capital gains tax. Usually, these involve putting enough of your money in a tax-safe investment so that you get some use out of your money rather than having to give it to the government.

Steps

Redirecting Your Income

1. Put more of your income into retirement accounts. Most reputable retirement accounts are tax-exempt or tax-deferred — that is, you either don't pay taxes on money you put into the account or you only have to pay them once you start withdrawing money from the account after you retire. In either case, capital gains you funnel into a retirement account won't be taxed immediately. For tax-deferred accounts, though you will eventually have to pay taxes, they will probably be lower than you initially would have had to pay (assuming your retirement income + withdrawals from your retirement account amounts to an income in a lower tax bracket).
   • Note, however, that most retirement accounts have a limit to how much you can add. For instance, a traditional 401k has a deposit limit of $17,500 per year.
2. Open a college savings account. If you're interested in saving for a child or grandchild's education while simultaneously avoiding capital gains tax, a college savings account is the way to go. 529 college savings plans operate on a tax-deferred basis like many retirement accounts. As an added bonus, they don't usually have a regular contribution limit like most retirement accounts do. Instead, they have a lifetime maximum amount — usually at least $200,000.
3. Put your money in a health savings account. Health savings accounts (HSAs) are just what they sound like — savings accounts that allow people to save for future medical expenses. Usually, money in these accounts is tax-exempt if it's withdrawn for medical purposes, making these a great choice for people looking to avoid capital gains. However, HSAs usually have several qualifying conditions that a person looking to open an account must meet. These usually include:
   • Having a qualifying high-deductible health insurance plan
   • Not being on Medicare
   • Not being a dependent on another person's tax return.
4. Put your assets in a charitable trust. For someone with a highly-valuable asset subject to appreciation (like, say, a collection of fine antiques), charitable trusts offer a great way to avoid paying capital gains on the sale of the asset. Generally, in this case, you give the trust your valuable asset, then the trust sells it for you. Because charitable trusts are tax-exempt, they don't have to pay capital gains taxes on the sale of the asset. After this, the trust pays you a certain percentage of the cost of the asset each year for an agreed-upon amount of time. After this, the money left over goes to charity.
   • To be clear, this method may not earn you as much money as you might from selling the asset yourself and keeping all of the money, even after taxes. However, it does ensure that all of the money from selling the asset is split between you and a charity of your choice, rather than going to the government.

Avoiding Taxes on General Gains

1. Hold on to your stocks. Capital gains result when you sell capital assets at a greater price than what you bought them for. If you don't sell your assets, you don't have to pay any tax. So, if you're thinking of selling some stocks, always remember that you have the option to hold onto them until a later date.
   • By waiting to sell, there's a possibility that you may be able to get a better price for the stocks in the future. However, it's also possible that the price of the stocks may decline over time.
2. Make gifts to family members. Every year, you are allowed to give $14,000 in tax-excluded gifts per individual recipient. If you give valuable stock to a trusted family member like a parent, child, or sibling, they can sell it for you and consequently pay as little as 0% in capital gains taxes (as long as their income puts them in a low tax bracket).
   • Obviously, you'll only want to use people that you absolutely trust. Giving someone stock or assets as a gift gives them legal possession of them, so, if there's any doubt in your mind about whether someone will give you your money back, choose someone else.
3. “Harvest” losing stocks. In some situations, selling a stock for a short-term loss can actually save you money in the long term by reducing the amount of money you pay in capital gains taxes overall. This is called "harvesting" your loss. For instance, if someone invests $10,000 in one company's stocks and the stock soon falls to $9,000, they may decide to sell, taking the $1,000 loss. Then, they will re-invest this money into a different stock. However, they can still use this $1,000 to offset other gains on their tax return. If the second stock does well, it's possible to have a greater return rate on your initial investment than you would have had by simply buying one stock and waiting for it to recover.
   • Note, however, that the IRS has enacted certain financial rules that can make this process difficult. For instance, your initial loss is disallowed if you use the money from the sale to purchase a very similar asset within 30 days.
4. Leave capital to others in your will. If you are elderly and have no immediate need for the capital you have accumulated, you may want to consider leaving it to a loved one in your will. When inherited capital is sold, the fair market value at the time of your death is used as the basis for any capital gains . Thus, the only gains that are taxable are the increases in value after the date of death. These gains can often be minimal, especially if the assets are sold soon after death.
5. Move to a tax-friendly state. As noted above, the base federal rates for income taxes are the same for every American and vary based on your taxable income. However, many states include their own capital gains taxes on top of the base federal tax. To minimize the amount of money that you have to pay in taxes, moving to a state with a lower state-level capital gains tax (or none at all) can be a smart long-term option. Though the process of moving to a different state can require a serious investment of time and money, it may make sense for people who stand to make a great deal of money from capital gains over the course of their life.
   • Seven states have no additional taxes on top of the federal rate: Alaska, Florida, South Dakota, Tennessee, Texas, Washington and Wyoming. California has the highest rate of any state, with a top rate of about 37%.

Avoiding Taxes on Property

1. Use a like-kind exchange on property worth more than the depreciated value. If you sell property for more than the depreciated value, you will pay capital gains tax on the difference between the depreciated value and the sale price. However, you can use a like-kind exchange at the higher value of the property to avoid capital gains tax. For example, if you have used equipment worth $5,000, but the depreciated value of the equipment is only $3,000, you can trade it in for $5,000 to buy new equipment, instead of selling it outright and paying capital gains tax on the $2,000 difference.
2. Exclude capital gains on the sale of residential property. Individuals or families selling their primary place of residence may be exempt from paying taxes on much (or even all) of the money made from the sale of the home. Using this strategy, an individual can exclude up to $250,000 in capital gains, while a couple filing jointly can exclude up to $500,000. However, to be eligible for this sort of exemption, you must meet certain ownership requirements:
   • You must have owned the residential property for a minimum of 2 years.
   • You must have occupied the property as your primary residence for at least 730 days (2 years), which don't need to be consecutive, during a 5-year period prior to the sale. You are allowed to rent the residence during the period that you don't live in it.
   • During the 2-year period prior to selling the property, you must not have excluded the gain on the sale of another home.
3. Invest in property improvements. Certain eligible home improvement projects used to get a home in selling shape can be used to reduce (or even eliminate) the capital gains tax on the sale of a home. These IRS-approved projects can effectively count against the sale price of the home, reducing the amount of money you owe in capital gains taxes. If the combined cost of these property improvements makes the effective price of the sale less than $500,000 for couples filing jointly or $250,000 for individuals, no capital gains taxes need to be paid at all. Approved expenses are listed in IRS publication 523 and usually include:
   • Additions of an attic, basement, room, patio, etc.
   • Plumbing, heating, and air conditioning
   • Appliances
   • Insulation and carpeting
   • In addition, certain fees associated with selling a home (like title transfer fees, etc.) can also be excluded.

Tips

• If you don't meet the requirements of the ownership test and use test to avoid capital gains tax on the sale of residential property, you may be able to claim a partial exclusion if you were to sell due to unforeseen circumstances, such as a change in job location or health.
• Military personnel and people in certain other specified government positions, who must live elsewhere for work, may have difficulty meeting the 2-year use test during a 5-year period. Therefore, these people have the ability to suspend the 5-year period while they are away for up to 10 years.

Warnings

• If you leave a large estate to others in your will, there may be inheritance tax due at the date of death.

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Sources and Citations

See also

• Determine Your Federal Tax Bracket
• Turn Someone in to the IRS
• Fill Out a US 1040EZ Tax Return
• Annualize
• Find a Federal Tax ID Number
• Fill Out a W‐4
• Account for Fixed Assets
• Calculate Tax on Bonus Payments
• Pay Less in Taxes
• Complete a W‐9 Tax Form

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