20 Ways to Avoid Capital Gains Tax on Investments
Here are some strategies to legally minimize or defer capital gains tax when managing investments.
- Daisy Montero
- 5 min read
Nobody likes paying more taxes than necessary, especially on investments. The right moves can help lower or even avoid capital gains tax. Holding investments longer, using tax-friendly accounts, and offsetting gains with losses are just a few ways to keep more of your money.
1. Use a Tax-Advantaged Account
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Accounts like IRAs and 401(k)s allow investments to grow tax-free or tax-deferred. Gains from these accounts are not taxed until withdrawal, and Roth accounts can offer tax-free growth altogether. Taking advantage of these options reduces immediate tax liability while growing wealth over time.
2. Hold Investments Longer for Lower Taxes
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Selling an investment too soon can mean higher taxes, as short-term capital gains are taxed at ordinary income rates. Holding assets for at least a year qualifies them for lower long-term capital gains tax rates. A little patience can lead to significant tax savings.
3. Offset Gains with Capital Losses
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Selling underperforming investments to offset gains is a strategic way to lower your tax bill. This method, known as tax-loss harvesting, helps reduce taxable gains while keeping your portfolio balanced. Any excess losses can even be carried forward to future years.
4. Take Advantage of the Primary Residence Exemption
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Selling your home at a profit may qualify for a capital gains tax exclusion. If you meet the residency requirements, up to $250,000 ($500,000 for married couples) of gains can be tax-free. This rule makes homeownership one of the most tax-efficient investments.
5. Gift Assets Ahead of Selling
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Giving appreciated assets to family members in a lower tax bracket can reduce or eliminate capital gains tax. This strategy works well for passing wealth while minimizing tax burdens. Just be mindful of annual gifting limits and potential estate tax implications.
6. Invest in Opportunity Zones
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Investing in Opportunity Zones can delay or even reduce capital gains tax. These government-designated areas offer tax incentives for long-term investments. Holding for at least ten years can even make future gains tax-free.
7. Use the 1031 Exchange for Real Estate
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Swapping one investment property for another using a 1031 exchange defers capital gains tax. The IRS allows investors to reinvest proceeds without paying taxes right away. Keeping the cycle going can grow wealth while delaying taxes indefinitely.
8. Donate Appreciated Assets to Charity
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Giving stocks or property to charity avoids capital gains tax and provides a tax deduction. The charity gets the full value, and you reduce taxable income. It is a win-win that benefits both you and a good cause.
9. Take Advantage of the Step-Up in Basis
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Thanks to the step-up in basis, inheriting assets can mean paying little to no capital gains tax. The value resets to the market price at the time of inheritance, eliminating past gains. Heirs can sell the asset immediately without paying taxes on years of appreciation.
10. Invest in Municipal Bonds
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Earning interest on municipal bonds is a tax-free way to grow wealth. These government-issued bonds provide steady income without capital gains tax on earnings. Choosing bonds from your state can even eliminate state taxes on interest.
11. Use Tax-Loss Harvesting Yearly
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Selling losing investments to offset gains helps lower your tax bill. The IRS allows excess losses to roll over into future years, reducing taxable income over time. Keeping an eye on your portfolio can turn losses into tax savings.
12. Spread Out Gains Over Multiple Years
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Selling investments in smaller amounts across several years can keep gains in a lower tax bracket. Large one-time sales can push income into a higher tax rate. Spreading out profits helps control taxes while still cashing in.
13. Move to a State Without Capital Gains Tax
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Some states do not charge capital gains tax, making relocation a smart move for big investors. Checking state tax laws before selling investments can lead to major savings. Moving is a big step, but it is worth it for some.
14. Invest in a Roth IRA
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Gains inside a Roth IRA grow tax-free, and withdrawals in retirement are not taxed. Contributions are made after taxes, so there is no tax bill when pulling money out later. It is a simple way to avoid capital gains tax while building long-term wealth.
15. Considered Tax-Managed Funds
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Some mutual funds and ETFs are designed to minimize taxable distributions. These funds use strategies like avoiding frequent trades to lower capital gains tax. Choosing the right investments can make a big difference in yearly tax bills.
16. Gift Investments to Family Members in a Lower Tax Bracket
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Passing investments to someone in a lower tax bracket can reduce or eliminate capital gains tax. If they sell the asset, they may owe little to no taxes, depending on their income level. This is a smart way to transfer wealth while saving on taxes.
17. Invest in Startups Using QSBS Rules
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Some small business stocks qualify for major tax breaks under the Qualified Small Business Stock (QSBS) exemption. Holding these stocks for at least five years can make capital gains tax-free. Investing in the right startups could lead to business success and tax savings.
18. Use an Installment Sale
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Selling assets in installments spreads out capital gains over multiple years. Instead of one big tax hit, taxes are paid on smaller payments. This method keeps gains in a lower tax bracket while securing steady income.
19. Convert Traditional IRA to Roth IRA at the Right Time
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Moving money from a traditional IRA to a Roth IRA means paying taxes upfront, but future withdrawals are tax-free. Timing the conversion when income is lower can reduce the tax bill. Making this switch early can lead to significant savings in retirement.
20. Plan Asset Sales Around Your Income Levels
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Selling investments in lower-income years helps avoid higher capital gains tax rates. Keeping track of yearly earnings and planning sales accordingly can keep tax costs down. Smart timing makes a big difference in what you owe.