A capital gain is a profit made from selling an asset such as a stock, bond or real estate. The U.S. government taxes capital gains at different rates. Short-term capital gains (held one year or less) are taxed at your normal tax rate. Long-term capital gains (held over a year) benefit from a reduced tax rate. There are multiple ways to avoid Capital Gains that are incentivized by the government.
10 Ways to avoid Capital Gains:
1. Matching losses
Capital losses can be used to reduce your taxes by matching your gains and losses the government allows you to use up to $3,000 of excess losses not used to cancel gains per year to reduce your taxable income. Losses in excess of matching gains plus $3,000 can roll over to future years.
2. Exclusion of Primary Residence
An individual can exclude up to $250,000 and $500,000 for a married couple of capital gains from the sale of their primary residence. Certain rules apply such as living in the house 2 out of the last 5 years.
3. Retirement accounts
One benefit of retirement accounts is that you can defer paying taxes on any gains until you take the money out. The downside is that you are taxed at the normal tax rate when you take the money out, thus losing the benefit of the long-term capital gain tax rate.
4. 1031 Exchange
This section of the tax code allows capital gains tax to be deferred with the sale of rental or investment property if the proceeds of the sale are put into a similar type of property within a certain amount if time. You will want to use a 1031 exchange accommodator to make sure you comply with all the rules.
IRC Section 1031 (a)(1) states: “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”
Contributing to a traditional IRA or 401k can reduce your income while in a higher tax bracket and can eliminate capital gains while trading in the account by deferring it.
Roth IRAs can avoid capital gains tax all together. A Roth IRA allows for tax-free growth for your life and your heirs lives.
6. Health savings accounts (HSAs)
These accounts allow for a tax deduction when contributing or investing in them. They also allow for tax free growth and it is possible to avoid paying taxes on this account if withdrawals are used for qualified health expenses only.
7. Gifting to family
By giving away a highly appreciated stock to a family member in a lower tax bracket you can avoid paying high capital gains tax. It will be subject to the same cost basis but this will be applied to the lower tax rate for the family member.
8. Gifting to a Charity
You can gift almost any appreciated asset to a charity and the charity will not pay capital gains on the stock upon selling. You can actually give more to a charity this way than by selling the stock yourself because you would have to pay capital gains.
9 Move States
Certain states charge higher capital gains tax with California ranking in at the highest at 37.1%.
Upon your death, your heirs get a step up in cost basis and do not have to pay capital gains tax except for retirement plans and annuities.