Can You Defer Capital Gains? An Overview of Methods

Capital gains are the profits realized from selling an asset for more than its original purchase price. These assets can include investments like stocks, bonds, real estate, or even personal property. The Internal Revenue Service (IRS) generally considers these gains taxable income.

Deferral means postponing the recognition of capital gains for tax purposes to a later period. This strategy shifts when the tax is due, rather than eliminating it entirely. While deferral does not always eliminate the tax, certain conditions or account types may allow for tax-free growth or withdrawals, which can effectively reduce or remove the tax burden over time.

Using Tax-Advantaged Accounts

Tax-advantaged investment accounts offer ways to defer capital gains or allow for tax-free growth and withdrawals. These accounts encourage long-term savings by providing specific tax benefits. Understanding how capital gains are treated within these structures can significantly impact an individual’s overall tax liability.

Traditional IRAs and 401(k)s allow investment growth, including capital gains, to accumulate tax-deferred. Taxes are not due on these gains until funds are withdrawn, typically in retirement. Contributions to these accounts may also be tax-deductible, reducing current taxable income.

Roth IRAs and Roth 401(k)s offer tax-free withdrawals in retirement. Contributions are made with after-tax dollars, but investment growth, including capital gains, and qualified withdrawals are entirely free from federal income tax.

Health Savings Accounts (HSAs) offer a “triple tax advantage” with tax-deferred growth on investments. Contributions are tax-deductible, investment earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free. HSAs are a powerful tool for healthcare savings and long-term investment.

529 plans allow investment growth, including capital gains, to accumulate on a tax-deferred basis. When funds are withdrawn and used for qualified education expenses, these withdrawals are entirely tax-free at the federal level.

Real Estate Related Strategies

Several strategies exist for deferring capital gains relevant to real estate transactions. These methods offer opportunities to postpone or reduce tax obligations associated with property sales. Each strategy has distinct requirements and benefits designed for different types of real estate holdings.

A 1031 exchange, also known as a like-kind exchange, allows an investor to defer capital gains taxes when exchanging one investment property for another “like-kind” property. The property must be held for productive use in a trade or business or for investment, not as a personal residence. This deferral continues as long as the investor continues to exchange properties.

To qualify for a 1031 exchange, specific timelines apply. After selling the relinquished property, the investor has 45 days to identify potential replacement properties. The purchase of the identified replacement property must be completed within 180 days from the sale date of the original property. A qualified intermediary typically holds the proceeds to avoid immediate taxation.

Opportunity Zones encourage investment in economically distressed communities. By reinvesting capital gains from a prior sale into a Qualified Opportunity Fund (QOF) within 180 days, investors can defer the tax on those gains. The deferred gain is recognized when the QOF investment is sold or by December 31, 2026, whichever comes first.

Holding a QOF investment for specific durations provides additional benefits. If held for at least five years, a 10% step-up in basis on the deferred gain occurs, reducing the taxable amount. Holding for at least seven years results in a 15% basis step-up. Any appreciation on a QOF investment held for at least ten years can be entirely tax-free.

The primary residence exclusion allows homeowners to exclude a significant portion of the gain from the sale of their main home from taxable income. Single filers can exclude up to $250,000 of gain, while married couples filing jointly can exclude up to $500,000. To qualify, the homeowner must have owned and used the property as their main home for at least two of the five years leading up to the sale.

This exclusion can only be claimed once every two years. This provision helps many homeowners avoid capital gains tax when selling their personal residence.

Other Capital Gain Management Approaches

Beyond specific account types and real estate strategies, other methods can help manage or reduce capital gain liabilities. These approaches often involve timing the recognition of income or offsetting gains with losses.

An installment sale occurs when property is sold, and at least one payment is received after the tax year of the sale. This method allows the seller to defer the recognition of capital gain, spreading the tax liability over multiple years as payments are received. The gain is reported proportionally as each payment comes in, rather than all at once.

This approach can be beneficial if it allows the seller to remain in a lower tax bracket in subsequent years, potentially reducing the overall tax paid on the gain. Interest received on the deferred payments is taxed as ordinary income. Installment sales generally cannot be used for marketable securities or if the property is sold at a loss.

Tax-loss harvesting involves selling investments at a loss to offset realized capital gains. Capital losses can reduce capital gains dollar-for-dollar. If capital losses exceed capital gains, up to $3,000 of the excess loss can offset ordinary income annually.

Any remaining capital losses beyond the $3,000 limit can be carried forward indefinitely to offset future capital gains or ordinary income. An important consideration in tax-loss harvesting is the “wash sale rule.” This rule disallows a loss if an investor sells a security and then buys a substantially identical security within 30 days before or after the sale date, covering a 61-day window.