How to Decrease Your Capital Gains Tax

Capital gains tax applies to the profit realized when an asset is sold for more than its original purchase price. This tax applies to various assets, including stocks, bonds, and real estate. This article explores methods to reduce capital gains tax liability.

Optimizing Holding Periods and Offsetting Gains

The duration an asset is held before its sale influences its tax treatment. Gains from assets held for one year or less are classified as short-term capital gains. These gains are taxed at ordinary income tax rates, which can range from 10% to 37% for the 2025 tax year, depending on taxable income and filing status.

In contrast, gains from assets held for more than one year are considered long-term capital gains. These gains benefit from lower tax rates: 0%, 15%, or 20% for the 2025 tax year. The specific long-term rate depends on the taxpayer’s overall taxable income.

Tax loss harvesting is another strategy that can reduce capital gains tax. This involves selling investments at a loss to offset capital gains realized from other investments. For example, if an investor sells a stock for a $5,000 gain and another for a $3,000 loss, the net gain for tax purposes becomes $2,000. Capital losses can first offset capital gains of the same type (short-term losses against short-term gains, long-term losses against long-term gains).

If net capital losses exceed capital gains, up to $3,000 of the net capital loss can be deducted against ordinary income in a given tax year. Any remaining net capital loss can be carried forward to offset capital gains or a limited amount of ordinary income in future tax years. A key rule in tax loss harvesting is the “wash sale” rule. This rule prohibits claiming a loss on the sale of an investment if one buys a “substantially identical” security within 30 days before or after the sale. If a wash sale occurs, the disallowed loss is added to the cost basis of the new shares, deferring the tax benefit.

Strategies Involving Asset Transfers

Transferring appreciated assets can offer avenues for reducing capital gains tax liability for the original owner. One method involves gifting appreciated assets to individuals in lower tax brackets, such as children or grandchildren. When the recipient later sells the asset, any capital gains are taxed at their lower tax rates, rather than the donor’s higher rates. The recipient assumes the donor’s original cost basis for the asset.

The annual gift tax exclusion allows an individual to give a certain amount of money or assets to another person each year. For 2025, this annual exclusion is $19,000 per recipient. A married couple can combine their exclusions to gift up to $38,000 per recipient. While gifts exceeding this annual exclusion count against the donor’s lifetime gift tax exemption, the strategy leverages the recipient’s lower income tax bracket for capital gains.

Donating appreciated assets directly to a qualified charity is another effective strategy. When long-term appreciated assets, such as stocks or real estate, are donated to a public charity, the donor can avoid paying capital gains tax on the appreciation. This results in tax savings, as the gain is removed from the donor’s taxable income. The donor may also claim an income tax deduction for the fair market value of the donated asset, subject to certain adjusted gross income limitations, up to 30% for appreciated property.

A donor-advised fund (DAF) serves as a vehicle for making charitable contributions of appreciated assets. With a DAF, donors contribute assets to a public charity that sponsors the fund, receive an immediate tax deduction, and avoid capital gains tax on the donated asset. The donor then recommends grants from the fund to their preferred qualified charities over time. This allows for flexibility in grantmaking while securing the tax benefits in the year of the initial contribution.

Specific Exclusions and Deferral Methods

Certain exclusions and deferral methods allow taxpayers to reduce or postpone capital gains tax. One exclusion applies to the sale of a primary residence. An individual can exclude up to $250,000 of capital gain from the sale of their primary residence, while married couples filing jointly can exclude up to $500,000. To qualify for this exclusion, the taxpayer must have owned and used the home as their primary residence for at least two of the five years preceding the sale.

The Qualified Small Business Stock (QSBS) exclusion, under Internal Revenue Code Section 1202, offers tax benefits for investors in eligible small businesses. For QSBS acquired after July 4, 2025, a tiered exclusion system applies. Stock held for at least three years qualifies for a 50% exclusion of the gain, four years for 75%, and five years or more for a 100% exclusion. Prior to this date, a five-year holding period was required for the 100% exclusion.

The exclusion is subject to limits, the greater of $15 million or 10 times the taxpayer’s adjusted basis in the stock. The issuing corporation must be a domestic C corporation with aggregate gross assets not exceeding $75 million at any time from its formation until immediately after the stock issuance. It must also be engaged in an active qualified trade or business.

Qualified Opportunity Funds (QOFs) provide a mechanism to defer, reduce, or eliminate capital gains tax by reinvesting eligible gains into designated economically distressed communities. To defer a capital gain, it must be invested into a QOF within 180 days of its realization.

The Qualified Opportunity Zone program has been extended, introducing a new deferral timeline for gains invested. These investments can have gains deferred for five years from the investment date, or until the investment is sold, whichever occurs first. Holding a QOF investment for at least 10 years can lead to the elimination of capital gains tax on any appreciation of the QOF investment itself.

An installment sale allows a seller to defer capital gains tax by spreading the recognition of the gain over multiple tax years. This method is used for the sale of real estate or other large assets where payments are received over more than one tax year. Instead of paying tax on the entire gain in the year of sale, the tax is paid proportionally as the principal payments are received. This is beneficial for managing annual taxable income and avoiding higher tax brackets in a single year.