Taxes apply to just about everything, including stocks and real estate. Capital gains taxes are levied on profits made from the sale of assets, and they’re a commonly misunderstood element of investing. In this post, we’ll break down capital gains taxes and explain how you can limit your financial burden come tax season.
Capital gains tax is a tax on the profits earned from the sale of non-inventory assets. The rate varies depending on how long the asset was held before selling.
Short-term assets are those held for less than a year, and they’re taxed as ordinary income. Your bracket depends on your earnings and filing status.
If an asset is held for longer than a year, long-term capital gains taxes apply. Like short-term taxes, the bracket you fall under depends on how you file and how much you make.
If the idea of paying taxes on your assets has you fretting, don’t fear––there are several strategies you can leverage that may limit your tax burden.
One effective strategy to defer or even avoid capital gains tax is by investing through tax-advantaged accounts, such as an IRA or a 401(k). These accounts allow investments to grow tax-free or tax-deferred, meaning you won’t pay capital gains tax as the investment value increases. The main types of tax-advantaged accounts include:
Opening tax-deferred accounts like these may effectively shield capital gains from taxes and offer a path to tax-efficient wealth growth for future needs.
No one likes to lose money, but by selling underperforming assets, you may actually offset the gains from profitable ones. This strategy, known as tax-loss harvesting, aims to balance capital losses with capital gains to lower taxes. Say you sell a stock with a $3,000 loss. You can use that to offset a $2,000 gain from another stock, basically eliminating the tax on the gain. The remaining $1,000 loss can further reduce your taxable income up to allowable limits.
Holding investments for longer can be a strategic approach to reduce the impact of capital gains taxes. By turning short-term gains into long-term gains, you can limit your tax burden. What’s more, a longer holding period may allow for the growth of compound interest, further boosting the investment’s value. This strategy aligns with a long-term, growth-oriented approach.
When you donate appreciated assets directly to a charity, you can avoid paying capital gains taxes on the appreciation, and you may also receive a charitable deduction for the fair market value of the donation, assuming you itemize deductions.
The Primary Residence Exclusion allows homeowners to exclude a substantial portion of capital gains from the sale of their primary residence from taxable income––in some cases, even eliminating the tax owed. Filers may exclude up to $250,000 of the gain from their income, or $500,000 if filing jointly with a spouse.
Capital gains come with one major downside, and that’s a higher tax burden. While taxes are an inevitable part of life, especially for those bringing in large amounts of money, you can preserve a substantial portion of your income by leveraging these strategies. Whether you choose to focus on tax-deferred accounts, charitable donations, or otherwise, you can take control of your tax situation and ensure more money ends up in your pocket. That way, you can build wealth and work towards the financial future you deserve.
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This content is provided for informational and educational purposes only and does not constitute investment, tax, legal or financial advice. The information is general in nature and does not consider any individuals’ specific objectives, financial situation, or needs. Nothing herein should be construed as a recommendation or solicitation to buy or sell any security, investment strategy or financial product. Individuals should consult their own qualified professionals regarding their specific circumstances. Past performance is not necessarily indicative of future results, and all investments involve risk, including the possible loss of principal.
