How Do I Avoid Capital Gains on My Taxes?

Selling investments or property at a profit triggers capital gains taxes, reducing the amount you ultimately keep. While these taxes are often unavoidable, legal strategies can minimize or eliminate them. Understanding tax laws for different assets and transactions helps lower your tax bill.

Excluding Gains on a Primary Home

Selling a home for more than its purchase price can result in a taxable gain, but the IRS allows homeowners to exclude a portion of these profits under specific conditions. The Section 121 exclusion permits individuals to exclude up to $250,000, while married couples filing jointly can exclude up to $500,000, provided they have lived in and owned the property for at least two of the last five years before the sale.

The two-year residency requirement does not need to be continuous, allowing flexibility for those who may have moved temporarily. The exclusion can also be used multiple times, provided at least two years have passed since it was last claimed. This benefits those who relocate frequently, such as military personnel or individuals moving for work.

For those who do not meet the full residency requirement, exceptions exist. Homeowners selling due to a job relocation, health issues, or other qualifying hardships may qualify for a partial exclusion, prorated based on the time lived in the home. For example, if a single homeowner lived in the property for one year instead of two, they could exclude $125,000 (half of the standard $250,000 exclusion).

Offsetting Gains with Capital Losses

When investments decline and are sold at a loss, these losses can offset taxable capital gains through tax-loss harvesting. The IRS allows taxpayers to reduce capital gains on a dollar-for-dollar basis. For example, if someone realizes a $10,000 gain from selling stocks but incurs a $7,000 loss from another investment, they are only taxed on the $3,000 net gain.

If total capital losses exceed capital gains in a given year, up to $3,000 of the remaining losses can be deducted against ordinary income. For married individuals filing separately, this deduction is capped at $1,500. Any unused losses beyond these limits can be carried forward indefinitely to offset future gains or income.

A key restriction is the wash sale rule, which prevents taxpayers from claiming a loss if they purchase a “substantially identical” security within 30 days before or after selling the losing investment. Instead, the disallowed loss is added to the cost basis of the newly acquired asset.

Holding Assets in a Tax-Deferred Account

Investing through tax-deferred accounts allows individuals to delay capital gains taxes, giving assets more time to grow. Retirement accounts such as traditional IRAs and 401(k)s allow investments to appreciate without annual taxation on gains, dividends, or interest. Taxes are owed only upon withdrawal, typically at ordinary income tax rates, which may be lower than capital gains rates in retirement.

Beyond retirement accounts, Health Savings Accounts (HSAs) and 529 college savings plans offer tax-deferred growth, with tax-free withdrawals for qualified medical or education expenses. Contributions to an HSA are pre-tax, and any capital gains or dividends earned within the account are not taxed if withdrawals are used for medical costs. Similarly, 529 plans allow investments to grow tax-free when used for tuition, books, or other eligible educational expenses.

Self-employed individuals and small business owners can benefit from SEP IRAs and Solo 401(k)s, which have higher contribution limits than standard IRAs. In 2024, the SEP IRA contribution limit is the lesser of 25% of compensation or $69,000, while the Solo 401(k) limit is $23,000 plus an employer contribution up to a total of $69,000. These accounts not only defer capital gains taxes but also provide tax deductions on contributions, lowering taxable income in the contribution year.

Utilizing Gains Exclusions for Inherited Assets

Inherited assets receive a step-up in basis, a tax provision that can reduce or eliminate capital gains when the asset is sold. Instead of calculating gains based on the original purchase price, the cost basis adjusts to the asset’s fair market value at the time of the original owner’s death. If a beneficiary sells an inherited asset shortly after receiving it, there may be little to no taxable gain.

For example, if a parent purchased stock for $50,000 and it appreciated to $200,000 by the time of their passing, the heir’s cost basis resets to $200,000. If the heir sells the stock at that same value, no capital gains tax is owed. This rule applies to real estate, publicly traded securities, and privately held business interests.

Certain assets, such as those held in retirement accounts, do not qualify for this adjustment, as withdrawals from inherited tax-deferred accounts are generally taxed as ordinary income.

Applying Income Threshold Provisions

Capital gains tax rates vary based on taxable income, and understanding these thresholds can help minimize or eliminate tax liability. The IRS categorizes capital gains into short-term (held for one year or less) and long-term (held for more than one year), with long-term gains taxed at 0%, 15%, or 20% depending on income.

For 2024, single filers with taxable income up to $47,025 and married couples filing jointly with income up to $94,050 qualify for the 0% capital gains tax rate. Taxpayers nearing these thresholds may benefit from deferring other income, increasing retirement contributions, or leveraging deductions to stay within the 0% bracket.

The Net Investment Income Tax (NIIT) imposes an additional 3.8% surtax on capital gains for individuals with modified adjusted gross income (MAGI) exceeding $200,000 ($250,000 for married couples). Taxpayers subject to NIIT may consider spreading gains across multiple years or utilizing installment sales to avoid crossing the MAGI threshold in a single tax year.

Timing Asset Sales to Lower Liability

The timing of an asset sale can significantly impact the amount of capital gains tax owed. Selling in a year with lower income can reduce the tax rate applied to gains. Individuals anticipating retirement or a temporary reduction in earnings may benefit from delaying sales until they fall into a lower tax bracket.

Another approach is installment sales, which allow sellers to receive payments over multiple years rather than in a lump sum. This spreads the tax liability over time, potentially keeping the seller in a lower tax bracket each year. This strategy is useful for real estate transactions, where a large gain could otherwise push the seller into a higher tax rate.