Rumors that President Joe Biden is looking to nearly double the capital gains tax rate on wealthy investors rocked the markets this afternoon, with the S&P 500 down 30 basis points in mere minutes following initial reports by Bloomberg. Luckily, there are a few ways investors can avoid the capital gains tax on stocks. In fact, it’s possible for you to pay 0% in capital gains tax… with a little foresight and planning.
The increase in capital gains taxes applies to individuals with income of $1 million or more, and takes the marginal tax rate from 20% to 39.6%. When combined with a pre-existing 3.8% surtax on investment income, that makes for an effective tax rate of 43.4%.
That’s pretty steep. So what can you do?
Let’s take a look.
Avoiding the Capital Gains Tax
- Hold investments for a year or more. Investments owned for longer than 12 months are taxed at a long-term rate that’s significantly lower than the short-term rate.
- Invest through your retirement plan. You can buy and sell investments via your 401(k) or IRA accounts without triggering capital gains taxes.
- Use capital losses to offset gains. Tax-loss harvesting is a popular strategy for offsetting the capital gains tax. By selling assets that have depreciated in value at the same time you sell assets that have gained, you can reduce the capital gains tax you owe. If your losses are bigger than your gains, you can use another $3,000 per year to offset regular income and roll over the remaining red ink to do the same thing in future years.
- Sell investments when income is low. Whether your income is lower because you got laid off or you just entered retirement, if your income drops enough to put you in a lower capital gains tax bracket, you can benefit by cashing out.
- Donate your stock and kill two birds with one stone. Instead of selling stock, paying the capital gains tax and then donating money to a charity, why not cut out the middle steps? You not only avoid the capital gains tax, but you get a bigger tax deduction and the charity gets a larger donation. Win-win.
- Don’t sell, just die. You can’t take it with you, but you can pass it on in your will. Typically the cost basis of investments is adjusted at the date of death, meaning minimal taxable gains when inheritors sell the stock at or near the day-of-death price.
What About That 0% Capital Gains Tax?
Beyond tax-loss harvesting, there are two main ways to qualify for a 0% capital gains tax rate:
- Opportunity Zones. Take your capital gains and reinvest them within 180 days in a Qualified Opportunity Fund. You’ll have to hold the money there for a decade, but at the end of those 10 years, you’ll have zero capital gains on the profit from the fund.
- The 10%-12% tax bracket. In 2021, this means singles making $40,400 or less and couples making $80,800 or less. “Even if your taxable income is normally too high to harvest gains with zero tax, there may be some years … where you can take advantage of this strategy,” says Kiplinger. That includes if you were temporarily unemployed, if you are self-employed but make variable income, and those near or at retirement ages.
On the date of publication, Vivian Medithi did not have (either directly or indirectly) any positions in the securities mentioned in this article.
