How to Get Out of Paying Capital Gains Tax

A capital gains tax is a tax on the profit from selling a capital asset, such as stocks, bonds, real estate, and collectibles. The tax is only triggered when you sell the asset and “realize” the gain. An increase in an asset’s value is an unrealized gain and does not create a tax liability until you actually sell the asset.

Calculating Your Capital Gain

The calculation of a capital gain begins with the asset’s cost basis, which is the original purchase price. This basis can be adjusted over time for additional investments, like property improvements, or reductions, such as depreciation deductions, creating an adjusted basis.

The formula for determining your gain or loss is to subtract the adjusted basis from the selling price. A positive result is a capital gain, while a negative result is a capital loss. For example, if you purchased a stock for $2,000 and sold it for $5,000, your capital gain is $3,000.

A significant factor in how this gain is taxed is the holding period. A short-term capital gain results from selling an asset owned for one year or less and is taxed at your ordinary income tax rates.

A long-term capital gain applies to assets held for more than one year. These gains are subject to more favorable tax rates of 0%, 15%, or 20%, depending on your taxable income and filing status.

Strategies for Deferring Capital Gains Tax

One method for postponing capital gains tax on real estate is a 1031 exchange. This allows an investor to sell a business or investment property and defer the tax by acquiring a “like-kind” property with the proceeds. The term “like-kind” is broadly defined for real estate, offering flexibility.

To execute a 1031 exchange, you must follow strict timelines. A potential replacement property must be identified within 45 days from the sale of the original property, and the acquisition must be completed within 180 days of the initial sale.

Another strategy involves investing in a Qualified Opportunity Fund (QOF). By reinvesting eligible capital gains into a QOF, an investor can defer the tax on that gain until the end of 2026 or until the QOF investment is sold, whichever comes first.

If the QOF investment is held for ten years or more, any appreciation on the investment itself can be permanently excluded from capital gains tax. This is a significant advantage realized through a long-term commitment.

Strategies for Reducing or Eliminating Capital Gains Tax

Tax-loss harvesting involves selling investments that have decreased in value to realize a capital loss. These losses can then offset capital gains. The rules require that losses first offset gains of the same type, meaning short-term losses are first applied against short-term gains.

If capital losses exceed gains, up to $3,000 of the excess loss can offset other income, like wages, annually. Any remaining losses can be carried forward to future tax years. Be mindful of the “wash sale” rule, which prohibits taking a loss if you purchase a “substantially identical” security within 30 days of the sale.

Homeowners can use the primary residence sale exclusion. A single individual can exclude up to $250,000 of capital gain from their main home’s sale, and this amount is $500,000 for married couples filing jointly. To qualify, you must have owned and lived in the property as your primary residence for at least two of the five years before the sale.

Donating appreciated assets, like stock, directly to a qualified charity can eliminate capital gains tax. You can generally claim a charitable deduction for the asset’s full fair market value at the time of donation, which allows you to avoid paying tax on the appreciation.

Timing an asset sale to coincide with a low-income year can also eliminate the tax. The tax code has a 0% tax rate for long-term capital gains for individuals whose taxable income falls below a certain threshold. Selling assets in a year of lower earnings might allow you to qualify for this 0% rate.

Inheritance and Estate Planning Considerations

When an individual inherits an asset, its cost basis is “stepped-up” to its fair market value on the date of the original owner’s death. This means the appreciation that occurred during the decedent’s lifetime is not subject to capital gains tax.

For example, if a parent purchased stock for $10,000 that was worth $150,000 on the day they passed away, the heir receives it with a new cost basis of $150,000. If the heir immediately sells the stock for that price, there is no capital gain to report.

This step-up in basis applies to assets like real estate and stocks, making it a valuable part of estate planning. It allows for the tax-free transfer of wealth that has appreciated over the original owner’s lifetime.

Additionally, transfers of assets between spouses are not considered taxable events. This applies to gifts made during their lifetimes as well as assets transferred at death, providing flexibility for married couples to manage property without immediate tax consequences.