Investment markets have been falling.
The most profitable investments of the last few years are in bear markets (down 20% or more) while many others are in corrections (down 10% or more).
Investors who held the assets during the sharp climbs of the law few years are looking to take some profits before they disappear. Many put off selling assets held in taxable accounts, because they didn’t want capital gains taxes to diminish their profits.
Fortunately, there are strategies that can reduce capital gains taxes
First, a little refresher.
After selling an asset, the gain is the amount realized on the sale (the sale price less any selling expenses such as commissions or trading fees) minus your tax basis in the asset.
Your tax basis is the cost of acquiring the investment, which normally is the purchase price plus any commissions or other expenses incurred on the purchase. Depreciation taken is subtracted from the basis of depreciable assets, such as real estate.
When the asset was held for more than one year, the gain is long-term capital gain, which is subject to lower tax rates. The gain is ordinary and taxed at the same rate as your other income when the asset was held for one year or less.
There’s a capital loss when the amount realized on the sale is less than the tax basis.
A capital loss first is deducted from capital gains for the year. When the losses exceed the gains, then up to $3,000 of capital losses can be subtracted against your other income. Any additional capital losses are carried forward to future years to be used the same way.
To reduce capital gains taxes, the first move should be to search the portfolio for assets with paper losses. Those assets can be sold so the losses offset all or part of the gains from selling the appreciated investments.
But capital losses aren’t always available to offset the gains.
One way to decide whether it’s time to sell is to estimate the percentage of the investment’s value that would be taxed. Compare that percentage to what you think is the potential market risk of not selling.
For example, an investor owns a stock worth $100,000 that he purchased years ago for $10,000, giving him a long-term capital gain of $90,000. He’s in the 20% capital gains tax bracket, so he would owe $18,000 in taxes after a sale. That’s 18% of the current market value and would be his guaranteed “loss” to taxes.
If the investor believes there’s a reasonable probability the stock will decline more than 18% and the decline won’t be temporary, then it makes sense to sell now, pay the tax, and invest the remaining $82,000 in another investment or hold it in cash. But if there’s a low risk of a greater than 18% sustained price decline, then the tax cost is greater than the market risk.
Another useful analysis is to look at the investment alternatives.
Suppose the investor believes the investment is near full value or for other reasons thinks meaningful appreciation over the next few years is unlikely.
He should consider how long it would take other investments to make up the 18% tax loss plus whatever additional appreciation or income he estimates he would have earned from continuing to hold the stock.
For example, a safe investment earning 5% annually would grow from $82,000 to $104,655 after five years, assuming no taxes on the annual income or growth.
There’s a lot of guesswork in these processes, but they ensure you consider the key factors and look closely at both current and potential investments.
You also should consider more than a straight sale of the investment. Here are the key strategies to consider.
Family gifts. When you give appreciated property to a family member, they take the same tax basis and holding period you had and will have the same amount of capital gain when they sell.
But the family member could be in a lower capital gains tax bracket, perhaps the 0% bracket. The family has more after-tax wealth if you give the asset to one or more family members in lower tax brackets and have them sell. That’s better than if you sell, pay taxes at your rate, and eventually give the after-tax amount.
The annual gift tax exclusion allows you to give any person up to $19,000 in 2025 free of any gift taxes. Any gift amount exceeding $19,000 reduces your lifetime estate and gift tax credit.
You want to be sure that the person receiving the gift isn’t subject to the Kiddie Tax, which would make the gain taxable at their parent’s top tax rate instead of the child’s.
Direct gifts to charity. Someone who is charitably inclined should consider donating all or part of an appreciated investment instead of cash.
The fair market value of the asset on the date of the gift qualifies for a charitable deduction for someone who itemizes expenses on Form 1040. Neither the donor nor the charity will owe capital gains taxes on the appreciation.
You can give to a donor-advised fund and decide later which charities will benefit.
Charitable remainder trust. A venerable way to reposition an appreciated investment is to create a charitable remainder trust and donate the asset to it.
A CRT will pay income to you (or other beneficiaries you name) for life or a period of years, whichever you select. The standard CRT pays income for life to the donor and his or her spouse.
After the income period ends, the assets remaining in the trust are transferred to one or more charities you named when the trust was created, though you can change the charities over time.
In the year appreciated property is transferred to a CRT, you qualify for a charitable contribution deduction equal to the present value of the amount the charity is estimated to receive in the future. The value depends on your age and current interest rates.
The CRT can sell the asset and reinvest in a diversified portfolio. The CRT doesn’t owe taxes on its annual income and capital gains.
The CRT assets aren’t included in your taxable estate.
The income distributed to you will be a combination of return of principal, capital gains, and other income.
Charitable gift annuity. The charitably inclined also can contribute an appreciated asset to charity in exchange for a charitable gift annuity.
The charity promises to pay income to the donor for life. The income will be less than a commercial annuity would pay, and the difference is a contribution to the charity.
The donor qualifies for a tax deduction of the estimated present value the charity will receive, which varies with interest rates and the donor’s age. The donor doesn’t owe capital gains taxes on the value of the property given to the charity.
A portion of the income payments will be taxable, because the payments will be divided between return of principal, capital gains, and other income.
Charitable lead trust. A charitable lead trust (CLT) has fewer tax benefits but doesn’t require you to completely surrender the principal.
A CLT pays income to one or more charities you select for a period of years you determine when creating the trust. After the income period ends you, or beneficiaries you designated, receive the property remaining in the trust.
A CLT can be structured so the donor qualifies for a charitable contribution deduction equal to the present value of the charitable contributions the trust will make. But the donor also would be taxed on the annual investment earnings of the CLT.
An alternative is to structure the CLT so the trust creator doesn’t receive a charitable contribution deduction and the trust is taxed on the trust’s income.
An installment sale. You might hear suggestions to spread the capital gains taxes over time by selling an appreciated asset using an installment sale. Taxes are due as installment payments are received.
The installment sale method can’t be used for sales of stocks or other securities and most often is used with real estate.
Congress tightened the rules regarding installment sales over the years. You don’t want to try using an installment sale without good tax advice.
A few more strategies. There are other ways to fully or partially shelter capital gains.
The property owner might be able to reinvest the sale proceeds in opportunity zone investments or use a like-kind exchange of similar property under §1031 of the tax code. You shouldn’t attempt these strategies without the guidance of a tax professional.
Taxes on stock gains might be deferred by using a strategy called selling short against the box. Some investment professionals can help you defer taxes using strategies known as collars, variable forward sales, and options. These also shouldn’t be attempted without the guidance of an experienced professional.
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