How to Avoid Capital Gains Tax in Massachusetts

Capital gains tax, a tax on the profit from selling an appreciated asset, is a financial consideration. Assets include stocks, bonds, real estate, and other investments. While taxable, federal and state laws offer strategies to reduce or eliminate this liability. Understanding these provisions is important for financial planning in Massachusetts.

In Massachusetts, capital gains are taxed at a flat rate, depending on the asset’s holding period. Long-term capital gains (assets held over one year) are subject to a 5% tax rate, aligning with the state’s general income tax rate. Short-term capital gains (assets held one year or less) are taxed at 8.5%. An additional 4% surtax applies to individuals with incomes exceeding $1 million, including capital gains, increasing the effective tax rate for high-income earners.

Excluding Gain from Home Sales

One strategy for reducing capital gains tax involves selling a primary residence. Federal tax law, Internal Revenue Code Section 121, allows homeowners to exclude a portion of the gain from selling their main home from taxable income. This exclusion is a direct reduction of the taxable gain, not a deferral.

To qualify for this exclusion, homeowners must satisfy both an ownership test and a use test. They must have owned the home and used it as their principal residence for a combined period of at least two out of the five years preceding the sale. These two years do not need to be consecutive.

The maximum exclusion amount is $250,000 for single filers and $500,000 for married couples filing jointly. This provision applies to the profit realized from the sale (the difference between the sale price and adjusted cost basis). For example, a single individual selling their primary residence for a $300,000 gain would only pay capital gains tax on the $50,000 exceeding the exclusion limit.

This exclusion can be used repeatedly, but is limited to one sale every two years. This exclusion applies only to a primary residence, not rental properties or vacation homes.

Using Losses to Reduce Gains

Capital losses are a tool for managing capital gains tax liability through tax-loss harvesting. These losses offset capital gains from other investments.

Capital losses offset capital gains dollar-for-dollar. For instance, if an individual realizes $10,000 in capital gains from a stock sale and simultaneously sells another stock at a $10,000 loss, the gain is entirely offset, resulting in no taxable capital gain for that year.

If total capital losses exceed total capital gains in a given tax year, individuals can use the excess loss to offset a limited amount of their ordinary income. The IRS permits individuals to deduct up to $3,000 of net capital losses against ordinary income annually, or $1,500 if married filing separately. This reduces taxable income.

Any unused capital losses exceeding the $3,000 (or $1,500) limit can be carried forward indefinitely. These losses retain their character, offsetting short-term gains first with short-term losses, and long-term gains first with long-term losses, before offsetting other types of gains or ordinary income.

Deferring Gains Through Qualified Investments and Exchanges

Beyond exclusions and loss offsets, investment vehicles and exchange mechanisms allow for capital gains tax deferral. These strategies postpone tax recognition until a later sale or event, allowing for continued investment growth. Two mechanisms are 1031 Like-Kind Exchanges and Qualified Opportunity Funds.

A 1031 Like-Kind Exchange, Internal Revenue Code Section 1031, allows investors to defer capital gains tax when exchanging one investment property for another property of a “like-kind” nature. This means properties must be similar in character or purpose, such as exchanging one rental property for another. The deferral applies as long as the exchange adheres to specific rules, preventing immediate taxation on the original property’s sale.

Strict timelines govern 1031 exchanges. After selling the relinquished property, the investor has 45 calendar days to identify potential replacement properties. Following identification, the investor has 180 calendar days from the sale of the relinquished property to acquire one of the identified replacement properties. Both periods run concurrently and are strictly enforced.

Qualified Opportunity Funds (QOFs) offer another capital gains deferral avenue. These funds invest in designated economically distressed areas known as Qualified Opportunity Zones. By investing realized capital gains into a QOF within 180 days of the original gain, individuals can defer the tax. The deferred gain becomes taxable on the earlier of the QOF investment’s sale or December 31, 2026.

If the QOF investment is held for at least five years, the basis of the original deferred gain increases by 10%. An additional 5% basis increase (for a total of 15%) is possible if the investment is held for at least seven years. If held for at least ten years, any appreciation on the QOF investment can be excluded from capital gains tax upon sale.

Gifting and Charitable Donation Strategies

Gifting and charitable contributions of appreciated assets manage capital gains tax. These approaches benefit the donor and, for charitable giving, the recipient organization.

Gifting appreciated assets, such as stocks or real estate, to an individual transfers potential capital gains liability. The recipient takes on the donor’s original cost basis. If the recipient later sells the asset, they are responsible for capital gains tax based on the difference between their selling price and the donor’s original cost. This strategy is advantageous if the recipient is in a lower tax bracket than the donor.

Individuals can gift up to a certain amount per recipient each year without incurring gift tax implications. For 2025, the annual gift tax exclusion limit is $19,000 per recipient. A married couple can double this amount, gifting up to $38,000 per recipient. Gifts exceeding this annual exclusion amount reduce the donor’s lifetime gift tax exemption.

Donating appreciated long-term capital gain property directly to a qualified charity avoids capital gains tax on the appreciated portion. When an asset held for more than one year is donated, the donor avoids paying capital gains tax that would have been incurred had they sold it first. The donor can claim a charitable income tax deduction for the fair market value of the donated asset, subject to adjusted gross income (AGI) limitations.

For donations of appreciated non-cash assets to public charities, the deduction is limited to 30% of the donor’s AGI, with any excess carried forward for up to five subsequent tax years. For real estate gifts exceeding $5,000, a qualified appraisal is required to substantiate the fair market value.