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How To Avoid Capital Gains Tax On Stocks

Capital gains tax is the tax that applies to the profit gained when you sell an investment. There are two types of capital gains tax: long-term and short-term. The short-term capital gains tax applies to any asset you’ve sold after holding it for less than a year. It is the same rate that you would pay on your ordinary income.

Long-term capital gains tax applies to any investments you sell after one year. The current federal long-term capital gains rates are 0%, 15%, or 20% (not including the state tax rate), depending on your income tax bracket. 

Ideally, however, you’d like to avoid paying capital gains tax altogether — or get the lowest rate possible. And, when it comes to capital gains tax on stocks, there are ways to reduce your liability. Here are some strategies to consider for avoiding capital gains tax on stocks. 

Be strategic with your adjusted gross income

Even though long-term capital gains are taxed at a lower rate, realizing these capital gains can push you into a higher overall tax bracket. And, which tax rate you fall into can change from year to year. For instance, compare the differences between a single filer in 2021 vs. 2022: 

  • Capital gains rate of 0%: AGI of $0 – $40,400 in 2021, vs AGI of $0 – $41,675 in 2022
  • Capital gains rate of 15%: AGI of $40,401 – $445,850 in 2021, vs AGI of $41,676 – $459,750 in 2022
  • Capital gains rate of 20%: AGI of $445,851 or more in 2021, vs AGI of $459,751 or more in 2022

The key takeaway: If you anticipate earning more in 2022 than in previous years, you may wish to hold on to your stocks to take advantage of a lower capital gains tax rate. Consider bundling your capital gains with other deductions to minimize the liability. 

Consider tax-loss harvesting

Tax-loss harvesting is a tactic where you sell some stocks (or other assets) at a loss to offset a capital gains tax liability. For instance, you could sell equities that have incurred an unrealized loss at the end of the year, claiming a credit against any realized gains that occurred in the portfolio. This strategy is usually used to limit short-term capital gains tax.

Be careful to avoid a wash sale if you choose to try tax-loss harvesting. A wash sale occurs when someone sells or trades a security at a loss and, within 30 days before or after this sale, buys a “substantially identical” stock or security. Essentially, if you choose to sell a stock at a loss, you’ll have a 61-day window around the date of the sale during which you’re not eligible to reinvest in the same equity. Critically the wash sale rules do not apply to crypto currencies currently as they are not securities.

Protect your equity in a charitable trust

There are a few ways to protect your capital gains while giving back. One option is to set up a Charitable Remainder Trust. This is a tax-exempt, irrevocable trust that distributes income to the trust beneficiaries at least annually for a specified period. When that period is over, the CRT donates the remainder — what hasn’t been distributed yet — to your chosen charity.  

Charitable remainder trusts are a win-win. It offers a way to stash your assets in the trust, receive an up-front tax deduction, defer your taxes on any gains you realize inside the trust so they can be reinvested. It also gives you a way to put the trust’s income to use for yourself, and then donate a portion of the assets to charity at the end of the trust’s term. 

Alternatively, you could donate shares of stock to a third-party charity. This option removes your capital gains tax liability; and, the market value of the shares on the day you donate to the charity can be used as a tax deduction, assuming you are eligible to itemize deductions on your tax return. 

Take advantage of the qualified small business stock exemption

The qualified small business stock exemption (QSBS) rule allows some owners of startup equity to eliminate 100% of the taxes—state and federal—on the greater of their first $10m of gains per asset or 10x the cost basis of an asset. 

Congress enacted the Small Business Stock Tax Exemption in 1993 to encourage investment in specific types of small businesses. It did this by providing a simple tax exclusion: Anyone who starts, invests in, or works for a small business can exclude certain gains when they sell their shares, with some exceptions. 

Read more: What Is QSBS and What Does It Mean For You?

If you buy and hold qualified small business stocks, you may be able to exclude up to $10 million in capital gains from your income.. 

Invest in an opportunity zone

The IRS established the Opportunity Zone program in order to revitalize economically distressed parts of the US. Entrepreneurs can invest their capital gains in opportunity zones, and in return defer or reduce the taxes on the reinvested capital gains until 2026 or when the investment is sold (if before that date). 

Holding an investment in a QOF comes with additional tax benefits

  • If the investor holds the QOF investment for at least 5 years, the basis of the QOF investment increases by 10% of the deferred gain.
  • If the investor holds the QOF investment for at least 7 years, the basis of the QOF investment increases to 15% of the deferred gain.
  • If the investor holds the investment in the QOF for at least 10 years, the investor is eligible to elect to adjust the basis of the QOF investment to its fair market value on the date that the QOF investment is sold or exchanged.

Ideally, if you foresee adding capital gains to your income this year, plan ahead to defer your capital gains tax until you can get the most favorable rate possible. As one expert notes, “[If] you hold your stocks until your death, you will never have to pay any capital gains taxes during your lifetime.” Reinvesting your equities gains or holding on to them for as long as possible is likely the best way to reduce your tax liability.   

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