Some Capital Gains Tax Strategies

Capital gains is the income that’s derived from the sale of a capital asset. Capital assets can be in the form of real assets, such as property, or financial assets, such as stocks or bonds. The capital gain is basically defined as the difference between the money that is realized from the sale of the asset and the price that was paid for it.

Capital gains and losses are classified as either long- or short-term. A long-term capital gain occurs when the asset is sold or exchanged after it has been held for more than one year. Short-term gains or losses are derived from the sale of assets held for less than one year. Each classification requires a different tax calculation and will ultimately incur different amounts of tax. Most long-term capital gains are taxed at a maximum rate of 15%. This rate is much lower than the maximum 35% rate that applies to ordinary income.

Every time a stock is traded, the investor is vulnerable to capital gains tax. Making purchases through a tax-deferred account can therefore save a substantial amount of money. Tax-deferred accounts come in many shapes and sizes. The most well-known are Individual Retirement Accounts (IRAs) and Simplified Employment Pension (SEP) plans. The basic idea is that the funds are not taxed until they are withdrawn, at which point they are taxed at the rate of the investor’s tax bracket. Waiting until after retirement to cash in will likely save even more money because the investor’s income will probably be lower due to the fact that he or she is no longer working.

Also, while the benefits of tax-deferred accounts are substantial on their own, they provide an additional benefit of flexibility, as investors need not be concerned with the usual tax implications when making trade decisions. Provided the funds are kept inside the tax-deferred account, they have the freedom to close out of positions early if they have experienced strong price appreciation, without regard to the higher tax rate applied to short-term capital gains.

In many cases, it’s a good idea to match the sale of a profitable investment with the sale of a losing one within the same year. This is because capital losses up to $3,000 can be used against capital gains, and short-term losses can be deducted from short-term gains. Losses in excess of the $3,000 limit can be carried over to future years.

There’s a very advantageous exemption to the home capital gains tax. If you’re single and you sell your home, you can exclude the first $250,000 in profit from being taxed. If you’re married and filing jointly, the exclusion doubles to $500,000. In most parts of the country, these exemptions will completely protect you from home capital gains tax. Even if they don't, the tax savings should still be substantial.

A 1031 Exchange is a way of deferring payment of capital gains tax on certain types of real estate. Normally, when a business property or investment is sold, capital gains tax must be paid. However, with 1031 exchanges, by replacing the property with another like-kind property within set time limits, payment of capital gains tax can be avoided.

Finally, a taxpayer can avoid the tax on long-term capital gains by donating his or her property to a recognized charity. If the sale of the property would result in a long-term capital gain, but the taxpayer donates the property to charity, tax on the long-term capital gain is avoided, and the taxpayer also receives a charitable contribution deduction equal to the fair market value of the property at the time of the donation.