These five tax planning strategies can help you minimize capital gains taxes and maximize your investment gains over time.

Tax season, though often daunting, isn’t just about navigating complex paperwork and deadlines. For many taxpayers, it also provides a unique opportunity to review the previous year’s financial decisions and outcomes, allowing you to fine-tune your tax strategy moving forward.

This period of reflection and analysis can be particularly valuable if capital gains taxes tend to be a significant component of your overall tax liability. These taxes can eat away at your investment earnings over time, reducing the nest egg you’ve worked so hard to build.

Fortunately, there are steps you can take to minimize the impact of capital gains on your investment portfolio and tax bill. By strategically managing your income and investment decisions, you can potentially lower your future tax burden and keep more of your hard-earned money in your pocket.

UNDERSTANDING CAPITAL GAINS TAXES

Capital gains taxes apply to the profit an investor earns when selling an asset outside of a qualified account, such as 401(k) or IRA. These assets can include securities like stocks and bonds, as well as physical assets like real estate and personal property.

For reporting purposes, the difference between the purchase price (cost basis) and the sale price of a taxable asset is a capital gain or loss. For example, suppose you purchase 100 shares of company stock at $50 per share within a taxable brokerage account.

You then sell all 100 shares when the price reaches $60 per share. The difference ($60 – $50 = $10 x 100 shares = $1,000) may be subject to capital gains taxes.

The actual tax rate you pay on this difference, 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 that you’ve held for one year or less. The IRS considers short-term gains to be ordinary income, which means they’re subject to the same tax rate as your wages or salary.
• Long-term capital gains are profits from the sale of an asset you’ve held for more than one year. These gains benefit from a lower tax rate than short-term gains, with rates depending on your taxable income and filing status.

Most taxpayers pay the long-term capital gains tax rate of 15%. However, the highest earners—single filers with incomes above $518,900 and joint filers with incomes above $583,750 in 2024—pay a long-term capital gains rate of 20%. Meanwhile, single and joint filers earning less than $47,025 and $94,050, respectively, in 2024 pay a 0% tax rate on long-term capital gains.

5 STRATEGIES FOR MINIMIZING CAPITAL GAINS TAXES

Understanding how capital gains taxes work and the strategies for managing them is essential for effective financial planning and investment decision-making. With education and planning, you can make informed buy and sell decisions, potentially minimizing your tax bill and improving your investment results.

#1: BE MINDFUL OF COST BASIS & HOLDING PERIODS

To minimize capital gains taxes, it’s crucial to be mindful of your cost basis and holding periods for any assets you plan to sell. This information can help you strategically plan your trades to maximize your after-tax returns.

First, holding an asset for at least one year before selling it typically results in a lower tax rate on the gains due to the preferential treatment of long-term capital gains. Furthermore, if you’ve purchased shares of the same asset at different times and prices, knowing your cost basis can help you identify which shares to sell to minimize taxable gains or maximize taxable losses.

To effectively implement these strategies, meticulous record-keeping is essential. You’ll need to track the purchase date, cost basis, and sale details for each asset.

Many brokerage firms provide tools and reports to help with this, but it’s also wise to consult with a tax professional or trusted financial advisor. They can provide guidance tailored to your specific situation, helping you navigate complex tax laws and optimize your investment strategy for tax efficiency.

#2: DIVERSIFY ACCOUNT TYPES

Diversifying your investments across different account types can be an effective strategy to manage and potentially minimize capital gains taxes over time. This approach leverages the unique tax treatment of various account types to optimize both your current and future tax liabilities.

Here’s how diversifying your assets across tax-free, tax-deferred, and taxable accounts can help you strategically manage capital gains taxes:

• Tax-Free Accounts (e.g., Roth IRA, Roth 401(k)). Tax-free accounts tend to be ideal for investments that may appreciate significantly since you can withdraw gains tax-free in retirement if you’re at least 59 ½ and meet the five-year rule.
• Tax-Deferred Accounts (e.g., Traditional IRA, 401(k), 403(b)). These accounts are generally well-suited for investments that generate regular income, such as bonds or dividend-paying stocks. Since taxes on earnings are deferred, compounding works in your favor, potentially increasing the growth of your investments until you’re ready to withdraw and possibly in a lower tax bracket.
• Taxable Accounts (e.g., Individual and Joint Brokerage Accounts). Taxable accounts are usually best for investments you plan to hold long-term, allowing you to capitalize on lower long-term capital gains tax rates. These accounts typically offer more flexibility than tax-free and tax-deferred retirement accounts. They also allow for tax-loss harvesting, a strategy that can offset taxable gains with losses.

By diversifying across account types with varying tax treatments, you can create a more flexible and tax-efficient investment strategy. This approach allows you to manage your current and future tax liabilities more effectively, potentially saving a significant amount in capital gains taxes over the long term.

#3: HARVEST LOSSES

Tax-loss harvesting is a strategy that involves selling investments at a loss to offset capital gains. By strategically realizing losses, you can minimize capital gains taxes and potentially reduce your taxable income.

For instance, if you sell investments that have lost value, you can use those losses to offset any capital gains you’ve realized in the same tax year. If your losses exceed your gains, you can use up to $3,000 of the excess loss to reduce your ordinary taxable income, carrying over any unused losses to future years. This strategy can effectively reduce your overall tax liability, allowing you to reinvest the savings or use them for other financial goals.

However, keep in mind that the IRS prohibits claiming a tax deduction for a loss if you repurchase the same security, or one substantially identical, within 30 days before or after the sale. Violating the wash sale rule can undo many of the tax benefits associated with tax-loss harvesting.

#4: MANAGE TAXABLE INCOME

Another way to potentially minimize capital gains taxes is to strategically manage your income. This may involve timing the realization of income, making charitable donations, contributing more to retirement accounts, or using other tax deductions and credits to lower your taxable income.

Indeed, effective income management can significantly influence both your ordinary income and capital gains tax rates. By managing your taxable income to keep it under certain thresholds, you can potentially qualify for a lower capital gains tax rate.

Managing your taxable income can also help you avoid the net investment income tax and potentially reduce state income tax liabilities. Avoiding these additional taxes can help preserve more of your earnings, maximizing your investment growth over time.

#5: GIFT OR DONATE APPRECIATED ASSETS

Lastly, gifting or donating appreciated assets can be an effective and altruistic way to minimize capital gains taxes.

First, you can gift appreciated assets to family members tax-free if your gift is below the annual gift tax exclusion, which is $18,000 per beneficiary as of 2024. Doing so allows you to shift the capital gains tax burden to someone in a potentially lower tax bracket if they eventually sell the assets.

In addition, by donating appreciated assets directly to a registered charity, you can avoid paying capital gains taxes on the increase in value. If you itemize deductions on your tax return, you can also deduct the full market value of the donation in the year you make it, significantly reducing your taxable income in some cases. Be sure to confirm that the charity you select can accept non-cash donations first.

MINIMIZE CAPITAL GAINS TAXES WITH SLOAN ADVISORY GROUP’S GUIDANCE

Optimizing your tax situation isn’t just about reducing your tax bill in the present year; it’s about making informed decisions that contribute to your long-term financial well-being. By understanding how capital gains taxes work and being aware of the various strategies to minimize them, you can potentially preserve more of your investment earnings, providing a valuable tailwind for your retirement nest egg over time.

Sloan Advisory Group can offer personalized advice, keep you informed of changing tax laws, and help you integrate these strategies into a comprehensive financial plan that’s aligned with your specific needs and goals. By examining your full financial picture, we can also help you identify additional tax planning opportunities throughout the year to maximize your financial resources.

Contact us to begin your financial journey.