The market is reaching a record high. Therefore, if you are considering selling stocks now or in the near future, you are likely to get capital gains taxes from the sale. If you hold stocks for more than a year, it would be better to tax long-term capital gains (rather than tax the normal returns on short-term sales). But the total tax payable may be enough to warrant some tax planning. Delay taxation when selling securities, or even avoid taxation altogether.
How Do Taxes Work on Stocks?
If you hold the stock for a year or less, the sale proceeds are usually taxed as short-term capital gains. If you hold the shares for more than a year before the sale, in the long run, the profits will be taxed in a shorter period of time.
The tax rate for short-term and long-term capital gains is based on your total taxable income. Your short-term capital gains are taxed at your marginal tax rate (tax rate).
For example, suppose you made $50,000 in taxable income in 2020 and sold $100,000 worth of stocks that you held for more than a year. You first pay taxes on your normal income and then pay a 0% capital gain rate on your normal income. The first $28,750 of income, because that part of your total income is less than $78,750. The remaining $71,250 bonus will be taxed at 15%.
6 Ways to Avoid Paying Taxes While Selling Stocks
Here are 5 tax planning ways you can eliminate paying taxes when selling your stocks.
1# Shifting to a Tax-Friendly State
Just to avoid paying capital gains tax may seem extreme. However, if you plan to shift to a tax-free state such as Florida or Nevada, consider postponing the sale so that you don’t have to pay CGT of the state.
Of course, for most people, moving the whole family is impractical. There is also no guarantee as the states that may be tax-friendly today might start introducing state CGT tomorrow!
2# Using Tax-Loss Harvesting
You can offset capital gains by selling the “losers” in your stock portfolio. If your loss exceeds your income, you can deduct up to $3,000 per year and carry the excess forward to the next few years.
The problem with this strategy is that your losses must be greater than your profits, which means that you have not made any money. If you have a large investment portfolio, the limit of $3,000 per year is not that high. Not to mention that putting those seemingly losers aside in such a turbulent market can be a huge risk if you don’t know how they will perform the next day or month.
3# Investing in Opportunity Zone
This is the latest, most difficult (and most controversial) way to delay or avoid capital gains taxes. The Tax Cuts and Jobs Act creates opportunity zones to encourage investment in low-income and disadvantaged communities. Three mechanisms are used to increase income through opportunity funds (an investment tool that invests in opportunity zones).
Firstly, when investors put existing assets into opportunity funds, they provide temporary tax deferral on capital gains previously received. These capital gains will be postponed or asset sales, whichever comes first.
Secondly, capital gains invested in opportunity funds for at least five years increased by 10%, and capital gains with a maturity of at least seven years increased by 15%.
Thirdly, they provide the possibility of permanently avoiding taxes on new capital gains. If the alternative fund is held for at least 10 years, investors do not need to pay any taxes on the capital gains generated through the alternative fund. Similarly, there is a caveat as the details of investing in the opportunity zone can be very complicated, so it is best not to try it yourself. Contact your tax advisor.
4# Qualified Small Business Stock
Qualified small business stocks are stocks issued by qualified small businesses as defined by the US Internal Revenue Service. This tax exemption aims to encourage investment in these small businesses. If the stock meets the requirements of Section 1202 of the IRS, a basic income of up to $10 million may be excluded from your income. Depending on when the shares are acquired, 50-100% of capital gains may not be taxable. To be safe, it is best to consult a tax expert who is knowledgeable in this area.
5# Stock Donation or Gifting
Do you plan to donate to a qualified charity? Instead of selling higher stocks, paying capital gains tax, and donating the proceeds in cash, it is better to donate stocks directly. This completely avoids capital gains tax. Higher tax deductions are generated for the full market value of donated shares held for more than one year, leading to larger donations.
If benefits increase your annual standard deduction, fund benefits will also reduce your total taxable income. If you are not sure about the charity related to an action, you can donate your shares to an approved endowment fund. If you are lucky enough to be a rich person, you can consider starting a charity or private foundation.
6# Hold onto Your Stocks till You Die
This may sound painful, but if you hold the shares until your death, you don’t have to pay capital gains tax throughout your life. In some cases, your heirs may also be exempted from capital gains tax because they can apply for claiming the inherited stock.
The basis is the value of the investment, including any commissions or transaction fees. An increase in the base means adjusting the base value to the present value of the investment at the time of the owner’s death. This can partially or completely exempt capital gains tax based on investment costs. For high-quality stocks, if your heir chooses to sell the stock, this can eliminate capital gains, which can save a lot of tax.
Hope this article helped you understand researched and easy ways to avoid paying taxes such as capital gains on selling your stocks and let us know if these tips helped you in the comment section below!