7 Clever and Legal Ways To Avoid Capital Gains Tax (It’s Not Too Late for 2024 Taxes)

Capital gains are incurred when shares of a stock are sold for more than you paid for them. The taxes on these gains will depend on how long the shares were held.

Understanding how capital gains taxes work can help you manage the tax bill incurred from stock sales, which is a smart money move when trying to build wealth. When investing money, you should always understand how it could be taxed.

Here’s how capital gains tax works with taxes and how you might avoid a big capital gains tax bill.

Capital gains as they pertain to stocks occur when an investor sells shares of an individual stock, a stock mutual fund, or a stock ETF for more than they originally paid for the investment.

ETFs and mutual funds can also incur capital gains realized from the sales of the stocks held within the mutual fund or ETF.

The Internal Revenue Service defines capital gains as either short-term or long-term:

• Short-term capital gains: Capital gains on stocks that are held for less than one year are taxed at your ordinary income tax rate. There is no different treatment for tax purposes.
• Long-term capital gains: If the shares are held for at least one year, the capital gain is considered to be long-term. This means the gain is taxed at the long-term capital gains tax rate, which is lower than the ordinary income tax rates for many investors.

The tax rates on long-term capital gains vary a bit based on your filing status and your adjusted gross income (AGI). 

Here are the capital gains tax rates for the 2024  tax years for the various tax filing statuses.

Tax year 2024

Managing the tax impact when investing in stocks is always a good idea. 

However, tax considerations should simply be a part of the process and not the driver of your investing decisions. That said, there are many ways to minimize or avoid the capital gains taxes on stocks.

While long-term capital gains are taxed at a lower rate, realizing these capital gains can push you into a higher overall tax bracket, as the capital gains will count as a part of your AGI. 

If you are close to the upper end of your regular income tax bracket, it might behoove you to defer selling stocks until a later time or to consider bunching some deductions into the current year. 

This would keep those earnings from being taxed at a higher rate.

Tax-loss harvesting is an effective tool whereby an investor intentionally sells stocks, mutual funds, ETFs, or other securities held in a taxable investment account at a loss. Tax losses can be used in several ways including to offset the impact of capital gains from the sale of other stocks.

Capital losses are used to offset capital gains as follows:

• Long-term losses offset long-term gains
• Short-term losses offset short-term gains

Any excess losses of either type are used to offset additional capital gains first. Then, to the extent that your losses exceed your gains for the year, up to $3,000 may be used to offset other taxable income. Additional losses can be carried over to use in subsequent tax years.

You might be able to avoid capital gains tax by donating to charity. Donating shares of stock to a charity offers two potential tax benefits:

1. You will not be liable for taxes on any capital gains due to the increased value of the shares.
2. The market value of the shares on the day they are donated to the charity can be used as a tax deduction if you are eligible to itemize deductions on your tax return. 

Qualified small business stock refers to shares issued by a qualified small business as defined by the IRS. This tax break is meant to provide an incentive for investing in these smaller companies. 

If the stock qualifies under IRS section 1202, up to $10 million in capital gains may be excluded from your income. 

Depending on when the shares were acquired, between 50% and 100% of your capital gains may not be subject to taxes. It's best to consult with a tax professional knowledgeable in this area to be sure.

An opportunity zone is an economically distressed area that offers preferential tax treatment to investors under the Opportunity Act. This was a part of the Tax Cuts and Jobs Act passed in late 2017. 

Investors who take their capital gains and reinvest them into real estate or businesses located in an opportunity zone can defer or reduce the taxes on these reinvested capital gains. 

The IRS allows the deferral of these gains through December 31, 2026, unless the investment in the opportunity zone is sold before that date.

This might sound morbid, but if you hold your stocks until your death, you will never have to pay any capital gains taxes during your lifetime. 

In some cases, your heirs may also be exempt from capital gains taxes due to the ability to claim a step-up in the cost basis of inherited stock.

The cost basis is the cost of the investment, including any commissions or transaction fees incurred. A step-up in basis means adjusting the cost basis to the current value of the investment as of the owner’s date of death. 

This can eliminate some or all of the capital gains taxes that would have been incurred based on appreciated investments' original cost basis. 

If stocks are held in a tax-advantaged retirement account like an IRA, any capital gains from the sale of stocks in the account will not be subject to capital gains taxes in the year the capital gains are realized.

In the case of a traditional IRA account, the gains will simply be added to the overall account balance and will not be subject to taxes until withdrawal in retirement. 

In a Roth IRA, capital gains are part of the account balance and can be withdrawn tax-free as long as certain conditions are met. This tax-free growth is one reason many people opt for a Roth IRA.

Stocks could be a solid wealth-building tool for some investors. But it’s important to understand how stocks can be taxed and to consider those tax implications in your financial planning.

Incurring capital gains means that you have sold shares of a stock for more than you paid for it, but proper tax planning can help manage your tax liability and help you get ahead financially.

If you have questions about your tax situation, consider speaking with a tax advisor.