Five ways to reduce your Capital Gains Tax

Photo Credit/Mary McLain

“Do you ever wonder how much you will pay in capital gains? Understanding your rate on capital gains can be important and can save you a tremendous amount of money.”

How to reduce your Capital gains tax

The first way to reduce your capital gains tax is extend your holding period. If you hold your stocks or bonds longer than a year, then you automatically lower your capital gains tax rate. Hopefully, holding the position for a year and a day will also increase the appreciation of that asset. Although it is not guaranteed it will appreciate, it is clear that holding the asset will reduce your capital gains tax rate. Current tax rates for long-term capital gains can be as low as 0% and top out at 20%, depending on your income. Please note that gains on the sale of collectibles are taxed at 28%.

The second way to reduce your capital gains tax is to offset your losses with capital gains. One way to effectively use this strategy is to sell a position at a loss while selling a position at a gain. Reporting the gain and using the loss to offset the gain will reduce net capital gain and thereby reduce your capital gains tax rate.

The third way to reduce your capital gains tax is to sell your primary residence. If you meet the ownership and use tests, you can exclude up to $250,000 if you are single, or $500,000 if you are married filing joint. Certain tests have to be met to meet this ownership criteria and you must use your house as a primary residence for two of the five years. Please note that you can meet the ownership tests for two different time periods, but both tests must be met within the five years.

The fourth way to reduce your capital gains is use the 1031 exchange. This allows you to sell an investment property and put off paying taxes on the gain, as long as you reinvest the proceeds into another “like-kind” property within 180 days. The definition of like property encompasses a broad perspective. This enables you to exchange an apartment building for a single rental property. Now this has been popularized by real estate investors, but some savvy investors have used it in the art world. As it stands, an art investor may exchange one like-kind piece of art for another and defer some or all of the tax that might otherwise be due on the gain.

The fifth way to reduce your capital gains is to reduce your taxable income. The capital gains tax rate is based on your income and utilizing different tax-saving strategies can be very effective. The point of lowering your capital gains tax rate depends on how well you can maximize your deduction and credits. Contributing the full amount allowed to a 401k or a traditional IRA will generate the largest deduction. The 401K maximum contribution for 2020 is $19,500. The traditional IRA maximum contribution is $6,000 or $7000 if you are age 50 or older. Either way you can reduce your capital gains tax rate by reducing your income. Please note that investing in municipal bonds can also reduce your tax bill through the triple tax exemption.