Congratulations! You have done the single most important step: Getting invested in the stock market! No, seriously, it is the most important step you have taken. Anything that comes after that step is optimization and finding your investment strategy. One important optimization is around taxes. Specifically how you can avoid paying capital gains taxes on stocks. With all that money you managed to grow, it would be a shame if you would have to give too much away, right?
In this blog post, you will learn some important lessons to help you pay less taxes on your stock gains. You can lower your tax bill and pocket more money in your portfolio. Let’s dive into 6 valuable tips on how you can avoid paying taxes on stocks.
- Hold your stocks for at least 1 year
- Question Your Sale Motivation – My 8-Question Shortlist
- Spread your stock sale over multiple years
- Offset Capital Gains with Losses
- Invest in Tax-Advantaged Accounts
- Consult with a Financial Advisor
- Final Thoughts – How To Avoid Paying Capital Gains Taxes On Stocks
#1 Hold your stocks for at least 1 year
For those who know me, I’m an advocate for long-term investing. This makes the #1 tip very obvious because if there is one thing you can easily avoid, it’s having to pay short-term capital gains tax. But what exactly is that, and how does it increase your taxes in a tax year?
Related Post: Do You Have To Pay Taxes On Stocks You Don’t Sell?
As I pointed out in a previous post about taxes you pay on your stocks, the Internal Revenue Service (IRS) differentiates between Short-Term Capital Gains and Long-Term Capital Gains. Any gain you realize by selling stocks falls into these two categories. If you hold the stock you sold for at least one year, it will be taxed as a Long-Term Capital Gain; otherwise, it will be taxed as a Short-Term Capital Gain. You will pay a lower rate for Long-Term Capital Gain. In some ways, these tax rules incentivize you to buy and hold stocks long-term. If you don’t, you will pay a higher rate. This rate is the same as the ordinary income tax rates you pay.
You must know your total taxable income for the year to determine your exact rate. If you are in a lower tax bracket, that tax rate is also lower.
| Filing Status | 10% Rate | 12% Rate | 22% Rate | 24% Rate | 32% Rate | 35% Rate | 37% Rate | |
|---|---|---|---|---|---|---|---|---|
| Single | $0 – $11,600 | $11,600 – $47,150 | $47,150 – $100,525 | $100,525 – $191,950 | $191,950 – $243,725 | $243,725 – $609,350 | $609,350+ | |
| Married filing jointly | $0 – $23,200 | $23,200 – $94,300 | $94,300 – $201,050 | $201,050 – $383,900 | $383,900 – $487,450 | $487,450 – $731,200 | $731,200+ | |
| Married filing separately | $0 – $11,600 | $11,600 – $47,150 | $47,150 – $100,525 | $100,525 – $191,950 | $191,950 – $243,725 | $243,725 – $365,600 | $365,600+ | |
| Head of household | $0 – $16,550 | $16,550 – $63,100 | $63,100 – $100,500 | $100,500 – $191,950 | $191,950 – $243,700 | $243,700 – $609,350 | $609,350+ |
Short-term capital gains tax rates for the 2024 calendar year
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | $0 – $47,025 | $47,025 – $518,900 | $518,900+ |
| Married filing jointly | $0 – $94,050 | $94,050 – $583,750 | $583,750+ |
| Married filing separately | $0 – $47,025 | $47,025 – $291,850 | $291,850+ |
| Head of household | $0 – $63,000 | $63,000 – $551,350 | $551,350+ |
Long-term capital gains tax rates for the 2024 calendar year
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | $0 – $44,625 | $44,626 – $492,300 | $492,300+ |
| Married filing jointly | $0 – $89,250 | $89,251 – $553,850 | $553,850+ |
| Married filing separately | $0 – $44,625 | $44,626 – $276,900 | $276,900+ |
| Head of household | $0 – $59,750 | $59,751 – $523,050 | $523,050+ |
A long-term investment strategy does ask you to hold your stocks for much longer. It’s more like a mindset you adopt. You buy stock and become a part owner of a company. You follow it, you research it, and create an investment thesis around it. This is much different than speculating that a stock will go up or down in the next 3 months. It is a much more informed decision you make. I believe that long-term investing is successful more often and for more people than short-term trading.
#2 Question Your Sale Motivation – My 8-Question Shortlist
So you’ve made up your mind and want to sell a stock from your portfolio. What I would like you to do is take a step back. Doing this can help you avoid paying capital gains taxes on stocks because it can prevent situations in which your sale isn’t a correct move.
I want to share my 8-Question Shortlist with you that you can use to evaluate your plan of selling stocks. Whenever you want to sell, ask yourself these 8 questions:
#1Did you stay away from planning this sale?#2Did your position grow too large?#3Does the company not meet your own standards anymore?#4Has the leadership changed recently?#5Is the company going to be disrupted by a competitor?#6Are you not interested in the company anymore?#7Did the company grow too big to succeed?#8Do you need the money for other things?
If you answered no to all the questions, you might want to stay away from your sale. There is no obvious reason for you to sell your stock. Of course, this shortlist is designed for long-term investment. It is one of the best ways to control your mindset in that specific situation. If you want to read more about this topic, I have a more detailed version of this shortlist in my guide, “Knowing When to Sell Your Stock: 9 Rules for Savvy Investors.”
#3 Spread your stock sale over multiple years
So, you are ready to sell your stocks. You have a real reason in mind and double-checked your intentions. If your position has grown large and the stocks you are about to sell cause a large tax liability, you can spread the sale out across multiple years instead. This move will lower your tax burden in the current year and spread it out. It becomes more manageable for you.
If you know your tax brackets, you will also be able to lower the amount of taxes you owe. You would only sell stocks that will not cause you to move to the next higher tax bracket. In future years, you will do the same so that the total amount of taxes you pay stays as low as possible. Try to time your sale towards the end of the year. That way you know more precisely what your total income is going to be for the year.
You can calculate the capital gain of your stock sale ahead of time. To do that, you calculate the spread between the cost basis of your stock (the amount you paid for it or your purchase price) and the current price. Multiply that by the amount of stocks you plan to sell to get your total capital gain.
Depending on your reason for selling, this can be a viable option. Of course, if you have real reasons to think that a company will return significantly less in the future, that’s a different situation. Then, I would not wait multiple years but instead move quicker and possibly use other methods to reduce or avoid paying taxes on stocks.
#4 Offset Capital Gains with Losses
Do you have stocks in your investment portfolio that are down for a long time? Are you convinced that they will not come back anytime soon? Maybe it’s time to realize that unrealized loss and move on. By selling your stocks at a loss, you can offset any other gain to reduce your amount of taxable income in the given year.
Remember that just because a stock is down doesn’t mean you have to sell the stock. Past performance is never a good indicator of future returns. If the company behind the stock is well-run, it might still be a perfectly fine investment. As an example, Amazon has been a fantastic long-term stock for investors. But did you know their stock was down 90% multiple times until now? As you can see, it can pay out to stay in the game. Of course, not every company will turn out the way Amazon did.
#5 Invest in Tax-Advantaged Accounts
If you invest long-term, consider investing inside a tax-advantaged account. This move can help you Avoid Paying Capital Gains Taxes On Stocks.
But what does that mean exactly? I’m talking about an IRA, Roth IRA, 401k account, etc. These accounts are taxed in different ways.
Capital asset gains and dividends are tax-deferred if you invest in a traditional IRA account. You will pay taxes the moment you withdraw the money from that account. In a normal brokerage account, you must report your dividend income annually in your tax report.
Investing in a Roth IRA makes your tax situation even better! Any capital gain you realize by withdrawing money from your account is completely tax-free. There are annual contribution limits to such accounts. Also, not everybody is eligible to have a Roth IRA. You are only eligible if your total annual income is below $153,000 if filing single, or $228,000 if filing jointly.
Maybe you have heard about something called backdoor Roth IRA as an option if you have a higher income. This means you convert a traditional IRA account into a Roth IRA account using a rollover. After opening your account, you contribute $6,500 (or $7,500 if you are over 50 years old). Once the account is converted, you can invest it and let it grow. You can do that once every year.
This process feels a lot like a loophole, and it is. But this conversion has been used for well over a decade by countless investors.
Your 401k account also does not create any tax burden as long as you don’t take out money. A lot of 401k plans come with an employer match that allows you to basically get free money. If your employer offers a match, make sure to max it out entirely.
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#6 Consult with a Fee-Only Financial Advisor
Is your personal situation too complex to handle alone? Do you still feel like you are leaving money on the table? Then, it might be time to speak to a financial advisor or tax professional. They will be able to assist you and will have access to your complete information.
Finding a good financial advisor is not easy. I recommend the Garrett Planning Network, the National Association of Personal Financial Advisors (NAPFA), and the XY Planning Network. These networks can get you in contact with a fee-only advisor. No matter how much money we are talking about, it will not change your costs.
Having a financial advisor and tax advisor can help you take advantage of all tax deductions for your tax return. They can help you make smarter decisions and increase your long-term gains.
Final Thoughts – How To Avoid Paying Capital Gains Taxes On Stocks
Being smart about your stock transactions can save you money big time! With the tips from this blog post, you are equipped with everything you need to reduce or avoid paying capital gains taxes on stocks.
You learned why it is important to hold your stocks for at least one year. With my 8-question shortlist for selling stocks, you now have a framework to double-check yourself before selling any stock. Spreading your sales over multiple years can help you minimize the tax burden in a single year, and you can offset your gains with realized losses from other stocks. With tax-advantaged accounts, you have another option to defer the tax liability or eliminate it entirely in the case of a Roth IRA. Finally, you learned that a fee-only financial advisor is an excellent option for you to get advice in the most complex personal situations.
