How to Defer Capital Gains: 4 Key Methods

Capital gains are profits from selling assets for more than their purchase price. The gain or loss is the difference between the selling price and the adjusted cost basis (original cost plus improvements and selling expenses). These gains are generally taxable in the year the asset is sold. Various strategies exist to postpone this tax liability, allowing capital to remain invested and potentially grow before taxes are due.

Reinvestment Strategies for Deferral

Reinvesting proceeds from asset sales into specific types of investments can provide a pathway to defer capital gains taxes. Two prominent methods involve like-kind exchanges for real property and investments in Qualified Opportunity Funds. Each approach has distinct requirements and timelines that must be met to qualify for the deferral.

Like-Kind Exchanges

Internal Revenue Code Section 1031 allows taxpayers to defer capital gains taxes by exchanging real property held for business or investment for other “like-kind” real property. This is a postponement, not an elimination, with the gain recognized later, typically when the replacement property is sold without another qualifying exchange. The Tax Cuts and Jobs Act of 2017 limited these exchanges exclusively to real property.

To qualify, specific timelines must be met. After selling the relinquished property, the taxpayer has 45 days to identify potential replacement properties in writing. The replacement property must be acquired within 180 days from the sale date, or by the tax return due date, whichever is earlier. These timeframes cannot be extended.

A qualified intermediary (QI) facilitates like-kind exchanges by holding sale proceeds, preventing constructive receipt of funds. This structures the transaction as an exchange, avoiding immediate taxation. The replacement property must be of equal or greater value. Any cash or non-like-kind property received (“boot”) may be taxable.

Qualified Opportunity Funds

Qualified Opportunity Funds (QOFs) offer another reinvestment strategy for deferring capital gains. QOFs invest in designated Opportunity Zones, economically distressed communities where new investments may receive preferential tax treatment. To defer a capital gain, an investor must reinvest the eligible gain into a QOF within 180 days of realizing it.

A QOF is organized as a corporation or partnership to invest in Qualified Opportunity Zone property. The fund must hold at least 90% of its assets in qualified opportunity zone property, measured on two annual testing dates. This property includes qualifying stock, partnership interests, or business property within an Opportunity Zone.

QOF investments offer tax benefits based on holding period. The initial capital gain is deferred until an inclusion event or December 31, 2026, whichever is earlier. Holding for five years increases the basis of the deferred gain by 10%, making only 90% taxable. Seven years provides an additional 5% basis increase, making 85% taxable. For investments held 10 years or more, appreciation on the QOF investment can be excluded from capital gains taxation upon sale or exchange.

Installment Sales for Deferral

An installment sale defers capital gains by spreading gain recognition and tax liability over multiple tax years. This occurs when at least one payment for property is received after the sale’s tax year. Instead of paying tax upfront, the seller reports a portion of the gain as each payment is received.

Taxable gain in an installment sale is recognized proportionally to payments received. Each payment consists of three parts: return of basis, taxable gain, and potential interest income. The gross profit percentage (gross profit divided by contract price) determines the taxable portion of each principal payment, which is then applied to ascertain the gain to be reported annually.

Certain property types do not qualify for installment sale treatment, including sales of inventory, publicly traded stock, and property sold by dealers. For qualifying sales, sellers report income on IRS Form 6252, “Installment Sale Income.” This form is filed in the year of sale and each subsequent year payments are received, tracking taxable and non-taxable portions.

If an installment sale includes deferred payments, unstated or inadequate interest may be subject to imputed interest rules, reclassifying principal payments as interest income. This interest is taxed as ordinary income, separate from the capital gain. The installment method offers flexibility, allowing sellers to manage their tax burden by aligning tax payments with cash flow, potentially staying in a lower tax bracket.

Charitable Trusts for Deferral

Charitable Remainder Trusts (CRTs) defer capital gains while supporting philanthropy. A CRT is an irrevocable trust where appreciated assets (e.g., real estate, stock) are transferred. The trust can then sell these assets without immediately triggering capital gains tax for the donor, allowing full, untaxed proceeds to be reinvested within the trust.

The donor or other designated non-charitable beneficiaries receive an income stream from the trust for a specified term (up to 20 years) or for their lifetime. After this period, remaining assets are distributed to qualified charitable organizations chosen by the donor. The trust itself is tax-exempt when it sells appreciated assets, deferring the capital gain.

Two primary types of CRTs exist: Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs). A CRAT pays a fixed annual dollar amount to the income beneficiary, determined at creation. A CRUT pays a fixed percentage of the trust’s annually revalued fair market value. CRUT payments fluctuate with trust performance, while CRAT payments remain constant.

While the CRT sale avoids immediate capital gains tax for the donor, income payments to the beneficiary are taxable. Distributions are taxed according to a four-tier system: ordinary income, capital gains (short-term and long-term), tax-exempt income, and return of principal. Deferral allows the appreciated asset’s full value to generate income, potentially increasing total return before the charitable remainder is distributed.

Loss Utilization for Capital Gains

Though not a direct deferral, strategic use of capital losses can reduce or postpone capital gains tax. This practice, known as tax-loss harvesting, involves selling investments at a loss to offset gains from other investments.

Capital losses offset capital gains dollar-for-dollar. If losses exceed gains, taxpayers can use up to $3,000 of the net capital loss to offset ordinary income annually. Remaining losses can be carried forward indefinitely to offset future capital gains and up to $3,000 of ordinary income. Carried-forward losses retain their short-term or long-term character.

The “wash sale rule” (Internal Revenue Code Section 1091) is a key consideration. It prevents claiming a loss if a “substantially identical” security is acquired within a 61-day period (30 days before, the day of, and 30 days after the sale). This rule stops investors from creating artificial losses by selling and immediately repurchasing an asset to maintain their position.

If a wash sale occurs, the loss is disallowed for the current year but added to the cost basis of the newly acquired, substantially identical security. This adjustment increases the new security’s basis, which can reduce future taxable gain or increase deductible loss upon its sale. The wash sale rule applies across all taxpayer-controlled accounts, including individual and retirement accounts.