⭐️First, let's review capital gains tax:
Capital gains tax is divided into "short-term capital gains tax" and "long-term capital gains tax." If you hold the stocks for less than a year, you will be taxed at the short-term capital gains tax rate, which is based on your ordinary income tax rate.
If you hold the stocks for more than a year, you will be taxed at the long-term capital gains tax rate, which is generally lower and categorized into 0%, 15%, or 20% based on your income for the year.
⭐️How to reduce capital gains tax on stock profits❓
Strategy 1: Hold stocks in the right tax-advantaged accounts.
Here, "tax-advantaged accounts" include Traditional and Roth IRAs, 401(k)s, HSAs, and other retirement investment accounts.
1⃣️ Trade high-return investments in tax-free accounts
Typically, investments with expected high returns should be held in Roth IRAs and HSAs. This is because you can withdraw funds from these accounts tax-free, meaning that all the growth will not increase your tax liability in the future.
2⃣️ Trade short-term capital gains investments in tax-deferred accounts
If you have actively traded mutual funds, bonds, or stocks, you can keep these investments in tax-deferred accounts like Traditional IRAs. Since short-term gains are usually taxed at the ordinary income tax rate, if you need to take distributions from these tax-deferred accounts, they will be treated as regular taxable income, just like your ordinary income, without any additional tax implications.
Strategy 2: Tax-Loss Harvesting can also effectively reduce capital gains tax
While we hope that every stock is profitable, selling stocks at a loss can reduce the net capital gains for the year. If you have significant gains on one stock, you can offset them by selling another stock at a loss.
By using Tax-Loss Harvesting, you can reduce your net capital gains. If your capital losses exceed capital gains for the year, you will have a net capital loss. In such cases, you can deduct up to $3,000 of capital losses from your income, further reducing your tax liability. Any capital losses exceeding $3,000 can be carried over to future years until fully offset.
⚠️Avoid the wash-sale rule: When using this method, be mindful of avoiding wash-sale. This means that if you sell a stock at a loss, you must wait at least 30 days before repurchasing it to be able to use that capital loss for tax purposes.
Strategy 3: Estimate your current year's income and corresponding tax rate bracket, and allocate capital gains accordingly
Both income and capital gains tax rates are progressive, meaning that the higher your income, the higher the tax rate.
➡️Before deciding to harvest gains or losses, consider your position in the current tax bracket. If you anticipate a decrease in income in the near future (e.g., retirement), you may consider waiting until then to sell your stocks and realize the gains.
Please note that this information is provided for general informational purposes only and should not be considered as professional tax advice. For professional analysis and tailored advice, please contact us. Thank you.