5 Key Strategies for Minimizing Capital Gains Taxes

For many, tax season is a demanding time marked by meticulous paperwork and strict deadlines. Yet, it also offers a unique opportunity for a comprehensive financial check-up. 

The process of gathering and reviewing your financial documents in preparation to file your taxes allows you to evaluate how well your investments are performing and if your financial strategies are truly working toward your long-term objectives. This information can empower you to identify opportunities to lower both your current and future tax liabilities, including capital gains taxes. 

These taxes can gradually eat into your investment earnings, diminishing the savings you’re diligently building. However, by understanding how capital gains taxes affect your financial goals and actively seeking ways to minimize their impact, you can enhance your investment results and ensure more of your hard-earned money remains in your pocket.

Understanding Capital Gains Taxes and Their Impact 

Capital gains taxes apply to the profit an investor makes from selling an asset for more than its purchase price. These assets can include stocks, bonds, real estate, and other investments. 

The impact of capital gains taxes on investment returns can be significant, especially when these transactions occur outside of a qualified retirement account, such as a 401(k) or an IRA, where investments can grow tax-deferred or tax-free. The actual tax rate, however, depends on how long you held the asset before selling it. 

In general, capital gains are split into two categories: 

• Short-term capital gains are profits from the sale of an asset held for one year or less. These gains are taxed as ordinary income, according to the investor’s income tax bracket.

• Long-term capital gains are profits from the sale of an asset held for more than one year. These gains benefit from a lower tax rate than short-term capital gains, with rates depending on the investor’s tax bracket and filing status. 

Most investors pay a 15% long-term capital gains tax rate. However, the highest earners—that is, single filers with incomes above $518,900 and joint filers with incomes above $583,750 as of 2024—are subject to a long-term capital gains rate of 20%. Conversely, single filers earning less than $47,025 and joint filers earning less than $94,050 pay a 0% long-term capital gains rate as of 2024. 

Indeed, capital gains taxes can lower the effective return on an investment, potentially reducing the amount of money available to reinvest and grow. Over time, the impact of capital gains taxes can compound, especially if you engage in frequent trading. Fortunately, there are strategies you can leverage to minimize this impact and potentially boost your long-term investment results.

Consider the following strategies to minimize capital gains taxes:

1. Consider Holding Periods and Cost Basis

To minimize capital gains taxes, it’s crucial to be mindful of holding periods and understand the cost basis of your investments. While this approach requires careful record-keeping and planning, it can lead to substantial tax savings, potentially enhancing your overall investment returns.

Since the long-term capital gains tax rate is generally lower than an investor’s ordinary income tax rate, holding investments for more than one year can significantly reduce your potential tax burden. On the other hand, selling an asset just before it qualifies for long-term capital gains treatment can result in a significantly higher tax rate.

In addition, if you’re selling stocks or other securities that you purchased at different times and prices, you can specify which shares to sell. This method allows you to manage capital gains taxes by selling shares with the highest cost basis first.

1. Diversify Account Types

Diversifying your investments across different account types is a strategic approach to managing and potentially minimizing capital gains taxes. This strategy involves allocating your investments among tax-free accounts, tax-deferred accounts, and taxable accounts. 

Each of these account types has distinct tax treatments for contributions, growth, and withdrawals, which you can leverage to optimize your tax situation both now and in the future.

• Tax-Free Accounts (e.g., Roth IRAs, Roth 401(k)s). Investors contribute after-tax dollars, but investments grow tax-free, and withdrawals in retirement are tax-free. Thus, Roth accounts can be ideal for investments you expect to appreciate significantly, especially if you anticipate being in a higher tax bracket in retirement.
• Tax-Deferred Accounts (e.g., Traditional IRAs, 401(k)s). Investors contribute pre-tax dollars, and investments grow tax-deferred until withdrawals begin, typically in retirement. These withdrawals are taxed as ordinary income. Tax-deferred accounts can be appropriate for income-generating investments like bonds since you don’t need to pay taxes on the interest payments each year. 
• Taxable Accounts. Investments in taxable accounts are subject to capital gains taxes upon their sale, so being mindful of holding periods and cost basis is critical. However, these accounts offer more flexibility than tax-advantaged accounts and allow for tax-loss harvesting, a strategy that can offset taxable gains with losses.

By diversifying your investments across these various account types, you can create a more tax-efficient investment plan that not only seeks to minimize capital gains taxes year-to-year but can also optimize your financial situation in the long term. Since this approach requires careful planning and an understanding of the tax rules that apply to each account type, it’s wise to work with a fiduciary financial advisor or tax expert to develop a personalized tax strategy. 

1. Use Tax-Loss Harvesting to Minimize Capital Gains Taxes

Tax-loss harvesting is an investment strategy that involves selling securities in a taxable account at a loss and then using those losses to offset capital gains, enabling investors to minimize capital gains taxes in a given tax year. In addition to helping to reduce taxes in the current tax year, tax-loss harvesting can contribute to a more tax-efficient investment strategy long-term. 

If your losses exceed your gains, you can use up to $3,000 of the net loss to offset ordinary taxable income like wages. You can also carry any remaining losses forward to future tax years, providing a potential tax benefit in subsequent years.

After selling underperforming investments, you can reinvest the proceeds in similar securities to maintain your portfolio’s allocation and growth potential. This can also be a prime opportunity to realign your portfolio with your investment goals and risk tolerance.

However, keep in mind the IRS’s wash sale rule prevents you from claiming a tax deduction for an investment you sell at a loss if you purchase a substantially identical security within 30 days before or after the sale. Violating this rule can offset the potential tax benefits of this strategy.

1. Manage Taxable Income

Strategically managing your income to minimize capital gains taxes is a nuanced approach that involves careful planning and timing of when you realize income and capital gains to align with years where you might be in a lower tax bracket. This strategy can help lower your overall tax liability, allowing you to keep more of your hard-earned money. 

Contributing to retirement accounts like a traditional IRA or a 401(k), for instance, can reduce your taxable income since you contribute pre-tax dollars. This not only helps you save for retirement but can also move you into a lower tax bracket, reducing your overall tax liability, including capital gains taxes. 

Other ways to reduce your income in a given tax year include contributing to a health savings account (HSA), if available, or strategically donating to charity. 

Timing the sale of assets to manage when you realize capital gains can also significantly impact your tax bill. For example, if you anticipate being in a lower tax bracket in a future year, it might make sense to defer selling profitable investments until then to benefit from lower capital gains tax rates.

1. Gift or Donate Appreciated Assets

Lastly, gifting or donating appreciated assets is a strategy that, in addition to potentially fulfilling your philanthropic goals, can also help minimize capital gains taxes.  

You can gift assets up to the annual gift tax exclusion amount (which is $18,000 per beneficiary as of 2024) to as many people as you like without incurring gift tax or using your lifetime gift and estate tax exemption. Gifting appreciated assets to family members in lower tax brackets can reduce the overall tax burden on those assets, as the recipient may pay a lower capital gains tax rate if they decide to sell.

Similarly, donating appreciated assets to charity can help you avoid paying capital gains taxes on the appreciation. Since public charities are tax-exempt, the recipient can sell the donated asset and reallocate the proceeds without incurring capital gains taxes.

Furthermore, if you itemize deductions on your tax return, you can deduct the full market value of the asset at the time of your donation, not just the amount you originally paid for it (up to IRS limits). This deduction can reduce your taxable income, potentially lowering your overall tax liability.

TrueNorth Wealth is here to help.

While these strategies can help you reduce your potential tax burden, their effectiveness varies based on your specific financial situation and goals. Additionally, changes in tax laws over time could affect the viability of these strategies.

If you’re looking for tailored strategies to minimize capital gains taxes and optimize your overall tax situation, TrueNorth Wealth is here to help. Our team of fiduciary CFP® professionals can help you develop a comprehensive financial plan and tax strategy, enabling you to enhance your investment outcomes and make the most of your financial resources. 

TrueNorth Wealth is among the top Wealth Management firms in Utah and Idaho, with offices in Salt Lake City, Logan, St. George, and Boise. At TrueNorth Wealth, we focus on helping our clients build long-term wealth while maximizing the enjoyment they receive from their money. We do this by pairing our clients with a dedicated CFP® professional backed by an incredible team.