Ways to Offset Capital Gains

Posted May 20, 2024

Ways to Offset Capital Gains

Profiting from the sale of an investment, such as rental property, land, or stock shares, will generate a capital gains tax liability. 

There are a variety of strategies you can deploy to offset capital gains taxes. Investment horizon, for instance, can make the biggest difference in your capital gains tax rate since long-term investments have lower capital gains tax rates compared to short-term rates. Investors who utilize tax-deferred retirement plans such as 401(k)s or IRAs can also shelter their gains. Capital losses also can be used to offset capital gains, since these losses will reduce your total taxable income and may put you in a lower tax bracket. Selecting specific shares to sell at certain times (specific share identification) also may help manage your cost basis and capital gains impacts.  

Let's look at five specific strategies you can use to help offset your capital gains tax burden. 

Investment Horizon: Wait a Year or Longer Before Selling 

If you hold an asset for a year or longer before selling it, any realized gain qualifies for long-term capital gains tax treatment.  

Long-term capital gains are taxed at 0, 15, or 20 percent depending on your income and tax filing status. Short-term capital gains taxes on assets held for less than one year, meanwhile, are taxed as ordinary income. Your tax liability on short-term gains could be as high as 37 percent. Since long-term capital gains receive more favorable tax treatment, it’s recommended that you hold investment assets for at least a year before selling.   

Tax Loss Harvesting 

With a strategy known as tax loss harvesting, you can offset capital gains with capital losses experienced during the tax year or by carrying them over from a previous year. Using tax loss harvesting, investors can lower tax consequences by selling securities at a loss. If losses exceed gains, taxpayers can use up to $3,000 a year to offset ordinary income on income taxes. 

Using an example, let’s say you made $10,000 on Asset A, but Asset B is down by $2,000. By selling Asset B at a loss, you can offset gains from Asset A and owe taxes on $8,000 instead of the full $10,000. If your loss from B was more than the gain from A, you can offset your entire gain and deduct $3,000 from your taxable income. 

Sell When You Have a Reduced Income 

If you or your spouse recently quit or lost a job, or if you’re about to retire, selling key assets during a low-income year could put you in a lower tax bracket. In certain situations, entering a lower tax bracket may lower the rate at which any realized capital gains are taxed.  

Reduce Taxable Income 

Reducing your taxable income is an effective way to potentially minimize your short-term capital gains tax rate. You can take advantage of deductions and credits before filing your tax returns or by contributing to a traditional IRA or 401(k). There are other ways to reduce your taxable income, such as investing in municipal bonds. The interest from most municipal bonds is exempt from federal and some state income taxes. For more credits and deductions to lower your taxable income, the IRS provides a database for credits and deductions for individuals.  

Defer Capital Gains With a 1031 Exchange 

A 1031 exchange allows investors to sell an investment property and roll the sale proceeds into a like-kind replacement property. By doing a 1031 exchange, you can defer your capital gains tax liability indefinitely. You can hold the asset or exchange for other properties depending on your investment strategy. If you bequeath your real property assets to your heirs upon your death, your beneficiaries will receive a one-time step-up in basis that can potentially eliminate any accrued capital gains tax liabilities. The rules for a successful 1031 exchange are complicated and follow a strict timeline. This strategy also requires help from a qualified intermediary. 

It’s not only the wealthy who can offset capital gains taxes. By knowing the right strategy for you, most taxpayers have the potential to save. Consult a tax professional to ensure you qualify for certain deductions.

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.

Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

Hypothetical examples shown are for illustrative purposes only.

Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.

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The Investor's Cap Gains Guidebook

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Re-invest your capital gains. Defer or Eliminate Taxable Income.

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