One of the best characteristics of the capital tax is that it is very flexible. What many people do not know is that when properly strategized, you can be in the group where the vast majority of your capital gains will never be taxed. Of course, this legal avoidance of having to pay the Tax Man is directly connected to the capital gains tax rate itself, so it is something worth keeping an eye on. Here are 10 ways to either reduce or completely sidestep paying capital gains taxes and improve your financial well-being.
1. Your employee 401(k) plan.
The more money you make, the greater the benefit this is to you. You are able to reduce your taxable income by increasing your contributions, and then take advantage of the 401(k) gap years, which are between the age of your retirement and the time you reach 70, to make withdrawals at the lower income bracket. All the time you are working you can actively trade in the account, so you get the best of both worlds.
2. Charitable gifts.
The knee jerk reaction for many people when they want to donate to a charity is to give cash. The capital gains problem with that is it doesn’t help to reduce your capital gains tax. Instead give stock that has appreciated in value. You get the same tax deduction but when the charity sells the stock you sidestep any capital gains tax. Also, because the stock was a donation to the charity they don’t have to pay any tax on the appreciation in value.
3. Create a relocation plan.
This does not necessarily mean moving every year, but homeowners can take their primary residence exclusion of up to $250,000 when selling their home. That amount doubles if you are married. If you plan moving ahead of time you will avoid paying taxes on the appreciated value of your home when you do sell decades later. But plan to make sure you maximize the benefit, rather than moving every other year.
4. Renovate your home.
A strategy used by the best real estate agents is to make a house they are planning to sell as their primary residence (see above). The fixing up that is being done increases the sale price. What it doesn’t do is to incur the capital gains tax because of the primary residence exclusion. It also provides added value to the neighborhood and community they will be shortly leaving.
5. Open a Health Savings Account.
Most people pay premiums on their health insurance coverage, but the HSA is one of the few investment accounts that actually allows you to get a tax deduction for making contributions. As long as you use the money for health related care costs, you don’t have to pay any taxes. So an HSA lets you invest and the profit you make you can keep and avoid paying any taxes on.
6. Keep the money in the family.
You can do this by giving stocks to family members who are in a lower tax bracket. You want to give the stocks that have appreciated the most in value to get the maximum benefit, and of course you want to make sure they stocks are going to go to a good cause. The capital gain is calculated by their assuming responsibility for the cost basis, but their lower tax bracket will be used to determine the actual capital gains tax. You can find a way to work things out.
7. Choose a lower tax bracket state to move to.
What does this have to do with Federal taxes? State taxes are figured into the capital gains tax rate, so the less your state charges you, the less you pay. As expected, the state of California has the highest tax rate, sitting at a painful 37.1%. Then there are the best states which add zilch to the rate: sparsely populated Alaska, South Dakota, and Wyoming; densely populated Texas, Florida, and Tennessee; and the middlin’ Washington (not the D.C.).
8. The 1031 exchange.
Sellers of rental or investment properties can avoid the capital gains tax by rolling over the proceeds to a similar type of investment within a 180 day period. Called a 1031 or like-in-kind exchange, this can get very complex, so be sure to work with a tax and investment consultant before moving ahead with the idea.
9. Don’t do anything until after you die.
Yes, we realize there really is nothing you can do with this once you’re gone, but from a tax perspective passing the appreciated value to your heirs amounts to paying zero taxes. True, it can be a problem for your heirs if they are not as savvy as you, but then you can rest at night knowing that you’ll never really know how things turn out.
10. Loss matching.
The simplest way was saved for the last. Losses you incur during the year can be used to offset gains you have made in other areas. Better than this, if you have losses that exceed other capital gains you are allowed to apply $3,000 of those capital losses against ordinary income. What is left after that (hopefully it isn’t a large dollar amount) can be used in future tax years.