Capital gains taxes can take a significant bite out of investment profits, but with careful planning, investors and business owners can reduce or defer these taxes. Here are some of the most effective strategies for managing capital gains taxes:
1. Borrow Against Your Asset Instead of Selling
One of the most powerful tax strategies for avoiding capital gains tax is borrowing against appreciated assets instead of selling. By taking a loan using stocks, real estate, or other investments as collateral, investors can access liquidity without triggering a taxable event. This strategy allows them to continue growing their investments while potentially deducting interest payments on the loan. Wealthy individuals often use this approach to fund lifestyle expenses or reinvest without incurring capital gains taxes.
2. Hold Investments for Over a Year (Long-Term vs. Short-Term Gains)
The IRS taxes short-term capital gains (held for one year or less) at ordinary income tax rates, which can be as high as 37%. Long-term capital gains (held for more than a year) are taxed at preferential rates of 0%, 15%, or 20%. Whenever possible, holding investments for over a year can significantly reduce tax liability.
3. Utilize the 1031 Exchange for Real Estate
Real estate investors can defer capital gains tax by using a 1031 exchange, which allows them to sell an investment property and reinvest the proceeds into another like-kind property without triggering immediate tax liability. This strategy is particularly useful for those looking to upgrade properties or diversify their real estate portfolio.
4. Harvest Losses to Offset Gains (Tax-Loss Harvesting)
Selling investments at a loss to offset capital gains can help reduce taxable income. If losses exceed gains, up to $3,000 ($1,500 for married filing separately) can be deducted against ordinary income, with the excess carried forward to future years. This strategy is particularly useful in volatile markets. There are funds and traders set up to maximize this strategy without running afoul of the straddle rules. Its outside the scope of this article, but look them up and you will find one pretty quickly.
5. Invest in Opportunity Zones
The Opportunity Zone program allows investors to defer capital gains tax by reinvesting gains into Qualified Opportunity Funds (QOFs). If the investment is held for at least 10 years, any appreciation inside the QOF is completely tax-free upon exit.
6. Use an UPREIT Structure for Real Estate
Property owners who want to sell but defer capital gains taxes can contribute their property into an UPREIT (Umbrella Partnership Real Estate Investment Trust) in exchange for operating partnership (OP) units. This allows them to continue deferring taxes under Section 721 while gaining fractional ownership in a diversified REIT. Secret trick: Using Section 733, you may be able to access cash in the future without triggering any tax.
7. Sell Stock in Years with Lower Income
Since capital gains tax rates depend on income, strategically timing the sale of investments in years with lower income (such as retirement years) can reduce the tax rate. Investors who can control their taxable income can often benefit from the 0% capital gains tax rate on long-term gains when staying under certain income thresholds.
8. Gift Appreciated Assets to Family or Charity
Gifting to Family: Transferring appreciated assets to family members in lower tax brackets can reduce overall capital gains taxes. If the recipient’s income is low enough, they may pay 0% in long-term capital gains tax when they sell.
Gifting to Charity: Donating appreciated stock or real estate to a 501(c)(3) charity avoids capital gains tax and provides a charitable deduction based on the asset’s fair market value (rather than cost).
9. Establish a Charitable Remainder Trust (CRT)
A CRUT (Charitable Remainder Unitrust) or CRAT (Charitable Remainder Annuity Trust) allows investors to sell appreciated assets inside the trust without immediate capital gains tax. The proceeds are reinvested, and the donor receives income for life or a set term, with the remaining assets eventually going to charity.
10. Invest in Tax-Efficient Funds
Actively managed funds often generate taxable capital gains distributions, even if the investor hasn’t sold their shares. Index funds and ETFs tend to be more tax-efficient because they trade less frequently, reducing taxable distributions.
11. Use Installment Sales or Deferred Sales Trusts for Business Sales
If selling a business or real estate, consider structuring the transaction as an installment sale and spread the gain over multiple years, potentially keeping the seller in lower tax brackets and reducing the overall capital gains tax owed.
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