When investments increase in value and you sell, you owe capital gains tax on the profit. The tax rate depends on how long you held the investment and your income level. Here's how to minimize what you owe.
Capital Gains Basics
The Formula
Capital Gain = Sale Price - Cost Basis
Cost basis includes:
- Original purchase price
- Plus: Commissions and fees
- Plus: Reinvested dividends (in mutual funds)
- Minus: Return of capital distributions
Short-Term vs. Long-Term
Short-term: Held 1 year or less → Taxed as ordinary income (10-37%)
Long-term: Held more than 1 year → Taxed at preferential rates (0%, 15%, or 20%)
Pro Tip
The difference between short-term and long-term rates can be 20%+ for high earners. Always consider holding period before selling.
Long-Term Capital Gains Rates (2024)
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | Up to $47,025 | $47,026-$518,900 | Over $518,900 |
| Married Filing Jointly | Up to $94,050 | $94,051-$583,750 | Over $583,750 |
Plus: High earners may owe 3.8% Net Investment Income Tax (NIIT) on top.
Tax-Efficient Strategies
1. Hold for Long-Term
The easiest strategy: Don't sell until you've held more than one year.
Example at $100,000 income, $10,000 gain:
- Sell at 11 months: ~$2,200 tax (22% bracket)
- Sell at 13 months: ~$1,500 tax (15% rate)
Waiting 2 months saves $700.
2. Harvest Gains at 0%
If your taxable income is low enough, you may owe 0% on long-term gains.
Who this helps:
- Early retirees before Social Security
- Year with job loss or unpaid leave
- Students with investment accounts
- Anyone with temporarily low income
Strategy: Sell appreciated holdings, immediately rebuy (no wash sale rule for gains). This "resets" your cost basis higher for future.
3. Tax-Loss Harvesting
Sell investments at a loss to offset gains.
The Math:
- $10,000 gain from Stock A
- $8,000 loss from Stock B
- Net taxable gain: $2,000
Rules:
- Losses offset gains first
- Excess losses offset up to $3,000 ordinary income
- Remaining losses carry forward indefinitely
Wash Sale Rule: Can't buy "substantially identical" security within 30 days before or after selling at a loss.
4. Asset Location
Hold tax-inefficient investments in tax-advantaged accounts.
In 401(k)/IRA (tax-deferred):
- Bonds (interest taxed as ordinary income)
- REITs (high dividends)
- Actively managed funds (high turnover)
In Taxable Accounts:
- Index funds (low turnover)
- Growth stocks (no dividends until sold)
- Tax-managed funds
5. Charitable Giving
Donate appreciated securities instead of cash.
Example: Stock bought for $5,000, now worth $15,000
If you sell and donate cash:
- Pay capital gains tax on $10,000 gain
- Donate $15,000 (or less after tax)
If you donate stock directly:
- No capital gains tax owed
- Deduct full $15,000 (if itemizing)
6. Qualified Opportunity Zones
Defer and potentially reduce gains by investing in designated areas.
Benefits:
- Defer original gain until 2026
- 10% basis step-up if held 5+ years
- Zero tax on QOZ investment gains if held 10+ years
Complexity: Requires investment in special funds; consult professional.
Estate Planning and Capital Gains
Step-Up in Basis at Death
When you die, your heirs receive investments at current market value (stepped-up basis), not your original cost.
Example:
- You bought stock for $10,000, now worth $100,000
- If you sell: $90,000 taxable gain
- If you die and heirs sell: $0 taxable gain
Strategy: Consider holding highly appreciated assets until death if you don't need the funds.
Gift During Life
No step-up. Recipients get your cost basis.
What NOT to Do
Don't Let Tax Tail Wag the Dog
A bad investment isn't worth keeping just to avoid taxes. 15% tax on gains is better than 100% loss.
Don't Trigger Gains Unnecessarily
Frequent trading, fund distributions, and short-term thinking create tax drag.
Don't Forget State Taxes
Many states tax capital gains as ordinary income. Plan for combined federal and state impact.
Tracking Cost Basis
Keep Records
- Purchase confirmations
- Reinvested dividend amounts
- All additions and sales
Brokerage Reporting
Brokerages track and report basis to IRS for securities bought after:
- 2011 (stocks)
- 2012 (mutual funds)
- 2014 (bonds, options)
For older holdings, you're responsible for records.
The Bottom Line
Capital gains taxes are significant but manageable with planning. Hold for long-term rates, harvest losses strategically, locate assets tax-efficiently, and consider charitable giving for highly appreciated securities. Always weigh tax impact, but don't let taxes override sound investment decisions.