How to Avoid Capital Gains Taxes When Selling Stocks

Although selling securities investments for profit can help you grow your wealth, capital gains taxes can reduce some of the value you’ve accrued while owning stock. However, various legal and financial strategies can help you manage or mitigate taxes from stock sales. The legal team at 453 Deferred Sales Trust Powered by Pennington Law can help you identify solutions tailored to your needs and objectives. Contact us today for a free initial case review to learn more about your options for avoiding or managing capital gains taxes when selling stock.

What Are Capital Gains Taxes?

The IRS and many state governments impose taxes on capital gains. A person or entity realizes capital gains when they sell a capital asset for more than the cost spent to acquire it or their cost basis in the asset. For example, suppose you purchase a parcel of real estate for $150,000 and sell it for $200,000. In that case, you might owe capital gains tax on the $50,000 of gain you realized from the sale.

When Would I Pay Capital Gains Taxes?

A taxpayer typically owes capital gains tax when they have a realized gain. Although a capital asset may increase in value during a taxpayer’s ownership, such increased value constitutes an unrealized gain. The increase becomes a realized gain when the taxpayer sells the asset and receives the sale proceeds. Thus, taxpayers usually pay capital gains tax on their tax return for the tax year in which they sold the asset. However, certain legal strategies enable taxpayers to defer paying capital gains taxes on the sale of an asset.

What Do Capital Gains Taxes Do to a Portfolio?

Selling stocks for a profit allows an investor to realize the gains on their investment and redeploy their capital into other investments that can provide a greater rate of return or improve diversification of the portfolio. However, capital gains taxes on stock sales reduce the total profits realized from investments.
This is because an investor will owe a percentage of their gains in capital gains taxes. Thus, capital gains taxes can slow the growth rate of an investor’s wealth. Capital gains tax may discourage investors from selling out of appreciated investments when asset allocation would enable an investor to redeploy their capital into higher-growth investments.

What Are the Differences Between Short-Term and Long-Term Capital Gains?

The federal government and several state governments impose different tax rates for short-term vs. long-term capital gains. A party realizes a short-term gain when it sells an asset during the same year it acquired it. However, capital gains become long-term when a party holds an asset for more than a year before selling it. The IRS taxes short-term capital gains at the same rate that taxpayers pay on their ordinary income. Conversely, federal tax law imposes a zero, 15, or 20 percent tax rate on most long-term capital gains, with the rate taxpayers pay depending on their income in the tax year.

Most taxpayers will pay a 15 percent tax on long-term capital gains. However, lower-income taxpayers may owe no capital gains tax, while high-income investors may pay a 20 percent long-term capital gains tax. Furthermore, the federal government imposes a maximum tax rate of 28 percent on Section 1202
qualified small business stock.

How Can I Avoid Capital Gains Taxes When Selling My Stocks?

Common strategies to avoid capital gains tax when selling securities include the following:

Donate Stock to Charity

You can mitigate your capital gains tax burden by donating some of your appreciated stock to qualifying charitable causes. By donating stock owned for longer than a year to a qualifying charity, you can deduct the stock’s fair market value from your income (subject to limitations). This can mitigate the burden of capital gains taxes from other stock sales. Although a recipient of a gift of stock usually inherits the donor’s cost basis in the stock, qualifying charities typically do not pay capital gains taxes when they sell donated stock.

Look Into Wash Sale Rules

Selling stocks for a loss may allow investors to offset gains from other stock sales. However, the IRS’s wash sale rules restrict the use of losses to offset gains. The wash sale rules prevent investors from artificially creating a tax loss when they do not change their investment position meaningfully. Under these rules, an investor may not claim a loss from a stock sale if they repurchase the same security or a substantially similar security within 30 days before or after the sale. The wash sale rule applies across all investment accounts owned by an individual and the individual’s spouse.

A “substantially identical” security usually refers to securities with close similarities in underlying assets, risk, and expected returns, such as two S& P 500 ETFs or a company’s stock. However, buying stock in a different company in the same industry would likely not trigger the wash sale rule.

When a wash sale occurs, the IRS disallows the taxpayer from deducting the loss and adds the disallowed loss to the taxpayer’s cost basis for their newly acquired stock.

Invest in Retirement Accounts

One standard method of tax-efficient investing involves putting capital for investment into tax-advantaged retirement accounts, such as 401(k)s, IRAs, and Health Savings Accounts (HSAs). An individual may choose to pay income tax on earnings they contribute to a retirement account (making it a Roth account) or may contribute earnings on a pre-tax basis and pay income taxes when they take distributions from the account after retirement. However, during a person’s working years, they can buy and sell stocks in the account without incurring capital gains tax.

Although tax-advantaged retirement accounts have annual contribution limits, a person can reinvest the money they would otherwise spend on capital gains taxes by trading securities in the account, allowing their wealth to grow faster than it would in a standard brokerage account.

Pass Your Stock on in Your Estate Planning

You can pass on the wealth you’ve generated through investment by leaving stock or other securities to beneficiaries through a will or trust. When a person inherits stock from another individual, they gain a “stepped-up” basis in the stock, with their cost basis becoming the value of the stock on the date of the
decedent’s death.

Offset Capital Gains Via Tax-Loss Harvesting

Investors can mitigate capital gains taxes from stock sales by adopting a tax-loss harvesting strategy. Under this strategy, an investor sells certain investments for a loss and uses those losses to offset gains from other stock sales. Tax-loss harvesting can reduce an investor’s capital gains tax liability in a tax year. Furthermore, if an investor has a net capital loss from stock sales in a tax year, they can deduct up to $3,000 ($1,500 if married filing separately) from their income. Taxpayers can carry unused losses to future tax years to offset capital gains.

However, investors using a tax-loss harvesting strategy should keep the wash sale rule in mind. Doing so can ensure they do not purchase stocks or other securities soon after a sale for a loss that might trigger the rule and result in a disallowance of taking the loss.

Would a 1031 Exchange or 453 Deferred Sales Trust Work?

Other strategies may also help investors manage capital gains tax liabilities from stock sales. Although investors cannot use a 1031 exchange, which only allows real estate or real estate interests, they might place their stock into a deferred sales trust. It’s something our law firm likes to call “The Tax Tool You Didn’t Know You Had.”

With a deferred sales trust (DST) – which takes advantage of the installment sales tax rules under IRC 453 – an investor transfers their stock to a DST managed by a bona fide third-party trustee in exchange for a contract that describes how the trust will distribute the proceeds from selling the stock to the investor. The investor then only pays capital gains tax when they receive sale proceeds from the trust, allowing them to defer paying the full capital gains tax burden in the year of sale.

How Can a Lawyer from 453 Deferred Sales Trust Powered by Pennington Law Help?

An attorney from 453 Deferred Sales Trust Powered by Pennington Law can help you manage taxes from stock sales by doing the following:

• Reviewing your current portfolio and discussing your financial needs and goals to identify potential tax solutions
• Developing tailored financial and legal strategies designed to help you achieve your investment objectives
• Walking you through your tax planning options to help you make informed decisions
• Ensuring the proper structuring of your legal strategies so you receive the intended tax benefits

Our national law practice, which earned recognition as the Best Deferred Sales Trust Law Firm in the U.S. of 2024, includes professionals with extensive experience in matters such as the following:

• Tax law
• Asset protection
• Financial advisory services
• Estate planning
• Wealth and fiduciary matters
• Professional third-party trustee duties
• Financial reinvestment
• Insurance

Contact Our 453 Deferred Sales Trust Lawyers Today

Before you sell securities, talk to an experienced attorney from 453 Deferred Sales Trust Powered by Pennington Law for help with tax planning to mitigate the financial implications of a sale. Contact our firm today for a free, no-obligation consultation with our deferred sales trust attorneys to discuss your
Options for managing capital gains tax when selling stocks.