Top 4 Ways to Minimize Your Capital Gains Taxes

future planning money mindset taxes Feb 27, 2021
Photo by the blowup on Unsplash

Capital assets are significant pieces of property- buildings, cars, land, large machinery, art, stock, cryptocurrency- that you make profits on when you sell them πŸ‘πŸš—πŸššβœˆοΈπŸš€

And because Uncle Sam is the worst uncle ever, he always wants his piece of that pie!

When you sell a capital asset, you have to pay a special tax on your profits from that sale- aka, the capital gains tax. So how do you (legally! ethically!) manage your capital assets to reduce your tax burden? πŸ€”

1) Invest in real estate 🏑🏒
Pandemic-related no-eviction policies are putting a damper on investors’ enthusiasm for real estate, but as a long-term investment strategy, real estate can be a very strong part of your portfolio. Owning real estate generally means you’ll earn two sources of income from one asset- rental income (taxed at regular income rates), and income when you sell your asset!

However, you want to avoid those pesky capital gains taxes if/when you sell your property, right? So there’s a great little loophole here- if you sell one property and purchase another, you don’t pay capital gains taxes on that sale (unless, of course, the property you purchase costs less than the property you sell).

Upside/downside: You may not have to pay capital gains taxes πŸ‘ but you won’t have cash in hand, either πŸ‘Ž

2) Invest in life insurance πŸ‘ΆπŸ‘©πŸ‘΄
Our grandparents’ access to old-fashioned, death-only insurance is a thing of times past. Sure you can find it, but investing in modern life insurance has great tax benefits- this is largely due to the fact that life insurance is an investment that grows over time, but is not considered a capital asset by the IRS! Here’s your tax benefits:

  • Build tax-deferred cash value, on par with stock market gains BUT-

  • You’re protected against all losses of value (think declines in real estate or stock market investments- those never happen in life insurance)

  • The cash value you stash in life insurance isn’t visible to the IRS on the FAFSA for the kids’ college applications- even though all other types of capital assets are included on the FAFSA

  • Transfers to other policies, & accessing your cash value, is never taxed

Upside/downside: …Um, let’s be real, there’s no downside here, and a whole list of upsides πŸ‘

3) Indulge in some tax loss harvesting.
Here’s how it works: Sell assets at a loss. Record that loss on your taxes- up to $3k/year- and you’ll reduce your tax burden by up to $750, if you’re in the 25% tax bracket. You can legally buy the same asset back if you wait 31 or more days, so it won’t impact your net worth much. However! You are purchasing that same asset at a lower cost basis, so you’ll pay more in capital gains taxes in the future, since your starting purchase price is lower than your original sale price.

Thus, tax loss harvesting helps defer taxes, not truly eliminate them; but as many say, “a tax deferred is a tax avoided”, so it’s personal preference whether or not to engage in this process. In addition, you need to work with an accountant to make sure you’re following all the rules, which eats into that sample $750/yr gain.

Upside/downside: It’s a fairly complicated process πŸ‘Ž for a somewhat minor gain πŸ‘

4) Donate to charity.
Planning on donating money to a charity? Instead of selling off stock or donating cash from your income, donate stock shares instead:

  • You won’t pay capital gains taxes

  • Your chosen charity won’t pay capital gains taxes

  • You get that warm fuzzy from doing a wonderful thing 😊

  • You’ll be able to make a larger donation, AND-

  • You’ll be able to deduct the full value of the donation from your taxes, not just the stock sale price

Upside/downside: …let’s be real, there’s a whole list of upsides here too πŸ˜πŸ‘

The only (minor) downside being that this doesn’t leave you with cash in hand… which wouldn’t be your goal, if you’re donating to charity!

Why didn’t I mention stock market investments? They build value over time, yes, but there is no way to avoid capital gains taxes on stock sales- the IRS has closed any loopholes there 🀷

True, you will not pay capital gains taxes on stock sales that are held in your 401(k) or Roth accounts; but you’ll pay income taxes on your gains when you access that money in retirement, so that’s not exactly a way to reduce your tax burden πŸ˜†

Speak with a tax pro to figure out which of these strategy/ies is right for you!

Now That's Smart Money 🧐

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