Whether you’re selling a home or stock, it’s important to understand how the IRS taxes capital gains. This is because capital gains tax rates vary by income level and how long you hold an asset.
Fortunately, there are several strategies you can use to minimize your tax bill. Some of these are simple, while others require more planning.
1. Tax-Grant Harvesting
If you’re a taxable investor, capital gains planning is important to maximize your after-tax returns. This strategy can help reduce your overall tax bill, and free up more cash to invest in new assets that may generate positive returns.
Generally speaking, this involves taking losses on investments that are not performing well and using the proceeds to offset any gains in other parts of your portfolio. You can use this strategy with individual stocks, exchange-traded funds (ETFs), mutual funds and cryptocurrencies.
The IRS has a few restrictions on this strategy, including the wash sale rule, which prevents investors from selling investments at a loss and buying them back immediately to avoid taxes.
This strategy can be a useful tool in many situations, but it’s not always the best way to optimize your after-tax returns. Ultimately, the goal is to keep your overall portfolio aligned with your goals. It is essential to enlist the help of a financial or tax professional to help you make the most of this strategy.
2. Offsetting Gains and Losses
Offset gains and losses are a key part of capital gains planning. They help you to strategically sell assets that have lost value so you can create net capital losses, which reduce your tax bill.
A common strategy is to use losses from an investment that has a higher tax rate to offset gains in another investment that has a lower tax rate. Depending on your tax bracket, this could save you as much as $8,050 on your annual tax bill.
To use this approach, you need to keep track of your short-term and long-term capital gains and losses. Then, you use the net of those two to determine your capital gain and loss for the year.
The order in which you use short-term and long-term losses is critical. You must first use your short-term losses to offset short-term gains, then your long-term losses to offset long-term gains. Lastly, if your losses exceed your gains, you can use the excess to offset the opposite type of gain.
3. Selling Winning Investments
The best part of capital gains planning is that you don’t have to stick with the same old stock chums to make your big tax break happen. In fact, re-sizing up your portfolio could be the smartest move you ever made for a tidy sum in free cash.
The best way to do it is by incorporating an active risk management strategy into your portfolio plan. This strategy will allow you to rebalance your portfolio as the market moves in your favor, thus mitigating the effects of market volatility and volatility related losses. This strategy will also help you identify, and avoid, potential market setbacks such as stock splits, mergers and acquisitions, and dividend cuts.
If you are unsure about what strategies may work for your specific situation, seek advice from your financial and tax professionals to determine how the best approach is tailored to your particular circumstances. They will be able to help you determine the most effective method to use to keep your current taxes low and reduce your future taxes as well.
4. Spreading Gains Over Time
If you have a high income, it can be a good idea to spread gains over time rather than paying all of your capital gain taxes in one year. This will allow you to avoid being bumped up into a higher tax bracket, which can lead to larger taxes.
Another way to spread your taxable gains is to make use of tax-deferred retirement accounts, such as IRAs and 401(k)s. These accounts allow you to defer paying capital gains taxes until you start withdrawing funds from the account once you reach retirement age.
This can be a great strategy for reducing your current and future capital gains taxes, especially when you have a winning investment in your portfolio. However, be careful not to repurchase a winning investment within 30 days of selling it as this could trigger what the IRS calls a wash sale.
