A person is liable to pay capital gains tax when buying or selling personal and investment assets. Many people find this a burden because they, after all, have to pay a bunch of other taxes – property tax, income tax, sales tax, payroll tax, and excise tax.
The rates of capital gains could be as high as 39.6%. But, there are multiple ways to keep it low and even reduce to 0%. Let’s explore some strategies that will keep the capital gains tax to the minimum:
Sell the Primary Residence
You can exclude up to $250,000 of capital gains if the sold house is your primary residence. A married couple can stretch the digits to $500,000! For this reason, many families needlessly sell and buy homes because living in the same house for decades warrants more taxes.
Take the Advantage of 1031 Exchange
A person can evade the depreciation recapture and capital gains taxes on the sale of investment or rental property, given that they have used the revenue of the sale into another same type of investment within 180 days or 6 months. This tax rule is known as a 1031 exchange.
Invest with a Traditional IRA and 401k
You won’t get any capital gains discount for using a traditional brokerage account for investment. However, retirement accounts such as 401(k) and IRAs work in a different way. Investing these accounts allows growing your money on a tax-deferred basis. It means that you will be excluded from paying capital gains along the way. You will be due for the tax only if you take withdrawals in retirement.
Roth IRA and 401k
Investing these accounts gives you even better options – don’t pay capital gains and enjoy tax-free withdrawals in retirement! Given that you have paid tax on deposits, these tax-free benefits will be extended to your heirs too. Roth accounts are excellent choices for those who are in in the higher tax brackets.
Similarly, investing a health savings account (HAS) also provides you with tax-free growth and cuts your capital gains to 0%.
Hold the Investments Longer
Your investment tax will vary depending on how long you hold it. You will have to pay at the rate of a short-term capital gains tax, which is similar to the traditional income tax rate, if the holding time is one year or less. However, holding it more than one year will award you with a more favorable rate. In fact, you don’t have to pay any capital gains at all if you are within the 15% tax bracket.
Keep Tracks of Home Renovation Costs
The money you have spent on improving the homes could excise a percentage of the capital gains. Keep records of all the home improvements you have done. If that basement renovation, swimming pool fence installation, or kitchen upgrades add value to your home, you can use the expenses to offset the capital gains tax.