Capital Gains Tax – What is it and Can I Avoid Paying It?
There are two tax types on the money you earn, ordinary tax rates and capital gains tax rates. Capital gains taxes are taxes on the money you’ve earned in your investments, including stocks, bonds, and real estate held for investment. You must report all earnings, but there are ways to minimize the taxes you owe.
What are Capital Gains Taxes?
Capital gains are the profits or the difference between the asset’s price when you bought and sold the investment.
If you earn a profit, it’s a capital gain; if you lose money, it’s a capital loss. While losing money is never fun, a capital loss can decrease your capital gains, decreasing your overall tax liability. Capital losses are capped at a maximum of $3,000 per year if you don’t have any capital gains to offset. The remaining balance is carried forward indefinitely and can be used in future years.
When you have capital gains, there are two types of taxes – short and long-term capital gains taxes.
Short-Term Capital Gains Taxes
Short-term capital gains taxes apply to earnings on investments you’ve held for less than one year. They have the same income tax rate as your ordinary income.
Long-Term Capital Gains Taxes
Long-term capital gains taxes apply to earnings on investments you’ve held for over a year. Depending on your income, they are taxed at lower rates of 0%, 15%, or 20%.
4 Ways to Avoid Paying Capital Gains Taxes
The good news is there are some ways to avoid paying capital gains taxes or at least to minimize the taxes you owe.
1. Defer Taxes by Contributing to your Retirement Account
Any earnings you make in your retirement account aren’t taxed until you withdraw the funds, and then they are taxed as income. This is because you don’t pay capital gains taxes on distributions during retirement, avoiding them altogether.
2. Use Tax Loss Harvesting
Tax loss harvesting means you sell assets at a loss to offset high capital gains on other assets. This can lower your tax bracket on the capital gains while offloading investments you know won’t bounce back.
Please note you must not buy back the same investment for 30 days to avoid a wash sale and losing the tax benefit.
3. Keep Investments for the Long-Term
You may have a long-term capital gains tax of 0%, depending on your income. In 2023, single filers with income less than $40,400 pay 0% long-term capital gains taxes. Remember, you only need to hold the investment for longer than one year to get long-term capital gains.
In addition, any inherited assets automatically receive long-term capital gains treatment, decreasing your tax burden.
4. Carefully Choose your Cost Basis
When you sell a portion of your stocks for a gain, consider selling only those with a lower gain or a loss based on the cost you paid for those particular shares. This works even if you made money overall on the stock, but keep the portion that earned the highest profits for now.
Final Thoughts
Learning how to manage your investments to minimize your tax liability is important. Without worrying about your tax liability, your portfolio could be worth much less than you anticipated.
The key is timing your investments so you have long-term capital gains, use tax loss harvesting, and take advantage of the opportunity to defer your tax liabilities.
If you want to learn more about capital gains and how to minimize your tax liabilities, contact Murtha & Murtha today.
