Trading and selling investments is all fun and games until you realize you are subject to tax on your earnings.
Although a tax liability on your capital gains is not a bad thing, there are a few legal tax strategies you might be able to apply to reduce the tax on your gains.
1. Hold Investments for at least one year
Long-term investments are generally held for more than one year (365 days plus one day) and are taxed at lower rates than short-term investments.
To determine how long you held the asset, you generally count from the day after the day you acquired the asset up to and including the day you disposed of the asset.
Gains on short-term investments are taxed at individual income tax rates.
For most taxpayers, long-term investments offer a greater tax benefit.
Let’s take a look at an example –
Kevin and Kim are both in the 24% income tax bracket. Both purchase 200 shares of Tesla at the same date and time.
Kevin sells his shares within 3 month, Kim sells her shares in Year 2.
The short term-capital gain on Kevin’s shares will be taxed at his income tax rate – 24%.
Kim’s shares will be taxed at the long-term capital gains rate of 15%.
On large gains, that 9% tax rate difference could translate to thousands of dollars. This is why many wealth advisors recommend buy and hold strategies for passive investors.
For exceptions to this rule, such as property acquired by gift, property acquired from a decedent, or patent property, refer to Publication 544, Sales and Other Dispositions of Assets; or for commodity futures, see Publication 550, Investment Income and Expenses (PDF).
2. Harvest Losses
You can decrease your taxable gains on appreciated stock by selling stock that has lost value. This method will net gains with losses, decreasing your overall capital gain tax liability. Of course, this has to make overall financial sense and is best discussed with an investment adviser.
Note that, If your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your income is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 21 of Schedule D (Form 1040 or 1040-SR) (PDF) .
3. Reduce Taxable Income
Both short-term and long-term capital gain tax is based on taxable income. When taxable income is reduced, there is a possibility your capital gain tax will be reduced as well. Here are a few logical ways to reduce your taxable income:
- Contribute to a traditional 401(k) or Roth IRA (must have earned income to contribute).
- Open a Health Savings Account to receive the Health Savings Account deduction (must have an eligible high-deductible medical plan).
- Donate to a qualified public charity to deduct contribution (must itemize deductions on tax return).
4. Donate Appreciated Stock
If the tax benefit of donating appreciated stock outweighs the tax liability to sell it, consider the donation. For taxpayers that itemize their deductions, donated stock can be deducted at fair market value. In 2020, most donors can deduct donated stock valued up to 60% of adjusted gross income.
Check out The Tax Side of Giving to learn more about the tax benefits of charitable donations.
Conclusion
If you have stocks that have appreciated in value, it is important to understand the tax implications of selling them.
Capital gains taxes can be significant, so it’s important to take all available deductions and minimize your taxable income.
Talk to your tax advisor about strategies for minimizing the amount of capital gains tax you pay on stock sales. By doing a little planning now, you can save yourself a lot of money down the road.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers before engaging in any transaction.
