Capital gains tax is a special tax that you must pay when selling an asset such as a house or securities at a selling price that exceeds its original cost. In this article, we will explore some common ways to reduce the capital gains tax you pay when selling various assets.
How Capital Gains Tax Works
Capital gains tax works differently from taxes on what is referred to as ordinary income or earnings from work or business operations. Capital gains tax is imposed on the sale of capital assets, which are assets that you own and use for yourself, your business, or for investment, including stocks, bonds, business equipment, and commercial buildings.
Consider the Cost of the Asset
Before looking for ways to avoid or reduce capital gains tax, you must consider the type of assets you wish to sell and their cost. The cost of the asset is the amount you paid to acquire the asset, and it can vary for different types of assets. For tangible assets like a car or house, the cost may include sales tax, installation costs, and property taxes (for the seller). For stocks and bonds, the original cost is usually the purchase price, including any commissions or transfer fees.
Investing for the Long Term
A common way to reduce capital gains tax is to hold investments for a longer period before selling them. Short-term capital gains tax (for assets held for a year or less) is assessed at a higher rate than long-term capital gains tax (for those held for over a year). Sometimes, there may not be a capital gains tax, depending on the owner’s tax bracket.
Offsetting Capital Gains with Capital Losses
At tax time, if you have losses from selling any capital assets, you can use those losses to offset any other capital gains. Simply put, you tally up all capital gains and subtract any losses. One method used for this process is called “tax loss harvesting at year-end,” where losses in certain investments are consolidated to reduce overall capital gains tax liability.
Using Tax-Deferred Retirement Plans
Capital gains are deferred in tax-deferred retirement plans such as 401(k) plans or Individual Retirement Accounts (IRA), meaning they are not taxed until you withdraw them. You can choose the year in which you withdraw funds from these accounts. For instance, you may withdraw them in years when you have lower income or lower capital gains, or when you have losses that you can offset.
Transferring Gains to Inheritance Taxes
Assets held until the owner’s death are not subject to capital gains tax when sold, but they may be subject to inheritance taxes. The inheritance tax rate is 35%, but it only applies to the total assets exceeding $11.7 million in value.
Excluding Capital Gains on Home Sales
Selling your home may result in paying capital gains tax on the net income from the sale. However, you may be able to exclude up to $250,000 of capital gains on the sale as an individual, or $500,000 if you are married and filing jointly.
Donating Appreciated Assets
Donating financial assets and other assets to charitable organizations may be a way to avoid paying capital gains tax on those assets, but there are some conditions for this process. To obtain the tax benefit, you must be able to itemize deductions, meaning that your total deductions must be greater than the standard deduction. For 2022, the standard deduction was $12,950 for single individuals and $25,900 for married couples. There are limits on the amount you can deduct in one year, and you can only donate to charities qualified by the IRS.
Investing
Opportunity Funds
Opportunity funds are investments in economically distressed communities called “Opportunity Zones.” These funds are essentially a means for high-income investors to defer paying capital gains taxes if they hold their investments for a specified number of years.
Frequently Asked Questions
Can I reinvest to avoid capital gains tax?
Do I have to buy another home to avoid capital gains tax?
At what age do I not have to pay capital gains tax?
How can I avoid capital gains tax when selling my home?
Thank you for using this article. We hope the information provided has helped you understand how to avoid or reduce capital gains tax.
Source: https://www.thebalancemoney.com/how-to-avoid-or-reduce-capital-gains-tax-7089624
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