The main ways to reduce capital gains tax

You can lower the capital gains tax you owe by holding investments longer, using tax-advantaged accounts, offsetting gains with losses, donating appreciated assets to charity, or stepping up the cost basis of inherited property. None of these eliminate the tax entirely, but each one reduces what you owe in a specific situation. The strategy that works depends on what you own, how long you have owned it, and your income level.

Capital gains tax applies when you sell an investment for more than you paid for it. The difference between your purchase price and sale price is your gain. The tax rate depends on how long you held the asset: assets held longer than one year are taxed at the long-term rate (0%, 15%, or 20%, depending on your income), while assets sold within one year are taxed as ordinary income at your regular tax rate, which is usually higher.

Key Takeaways

  • Holding an investment for more than one year before selling drops your tax rate from your ordinary income rate to the long-term capital gains rate, which is typically lower.
  • Tax-advantaged accounts like 401(k)s, traditional IRAs, and Roth IRAs let you buy and sell investments inside the account without triggering capital gains tax until you withdraw the money.
  • You can offset capital gains by selling investments at a loss in the same year, a strategy called tax-loss harvesting.
  • Donating appreciated stocks or mutual funds directly to a charity lets you avoid the capital gains tax on the appreciation and claim a charitable deduction.
  • Inherited property receives a "step-up" in cost basis, meaning the tax is calculated from the date of death rather than the original purchase date, often eliminating or reducing the tax.

Hold investments for longer than one year

The simplest way to reduce your capital gains tax is to hold an investment for more than one year before selling. Assets held longer than one year may have access to for long-term capital gains rates, which are 0%, 15%, or 20% depending on your total income. Assets sold within one year are taxed as ordinary income, which can be 10%, 12%, 22%, 24%, 32%, 35%, or 37% depending on your tax bracket.

For example, if you buy a stock for $5,000 and sell it for $7,000 after 11 months, the $2,000 gain is taxed at your ordinary income rate. If you wait one month longer and sell it after 13 months, that same $2,000 gain is taxed at the long-term rate. The difference in tax owed can be hundreds of dollars on a moderate gain.

This approach works only if you can afford to wait. If you need the money sooner or the investment is declining, holding longer may not be practical. But if you have flexibility, timing your sale to cross the one-year mark is one of the easiest tax reductions available.

Use tax-advantaged retirement and investment accounts

Tax-advantaged accounts let you buy and sell investments inside the account without triggering capital gains tax each time. You only pay tax when you withdraw money from the account (or in some cases, never). Common accounts include 401(k)s, traditional IRAs, Roth IRAs, and HSAs (health savings accounts).

In a 401(k) or traditional IRA, you can trade stocks, mutual funds, or bonds as often as you want without owing capital gains tax on the gains inside the account. You pay tax only when you withdraw money in retirement, and then you pay tax on the full amount withdrawn, not just the gains. In a Roth IRA, you pay no tax on withdrawals at all, including the gains, as long as you follow the withdrawal rules.

The catch is that these accounts have contribution limits. For 2024, you can contribute up to $7,000 per year to an IRA (or $8,000 if you are 50 or older) and up to $23,500 per year to a 401(k) (or $31,000 if you are 50 or older). If you have more money to invest, you can use a regular taxable brokerage account, but gains in that account are taxable each year.

Offset gains with losses (tax-loss harvesting)

Tax-loss harvesting means selling an investment at a loss to offset gains you made elsewhere. If you sold Stock A for a $3,000 gain and Stock B for a $2,000 loss in the same year, you can net the loss against the gain and owe tax on only $1,000 of gains instead of $3,000.

If your losses exceed your gains in a year, you can deduct up to $3,000 of the excess loss against your ordinary income. Any losses beyond that carry forward to future years, so you can use them to offset future gains or future income.

The main limitation is the wash-sale rule. If you sell a stock at a loss, you cannot buy the same stock (or a substantially identical one) within 30 days before or after the sale, or the loss is disallowed. You can buy a similar but different investment when ready, such as a different index fund or a competitor's stock, to stay invested while preserving the loss.

Donate appreciated assets directly to charity

If you own stocks, mutual funds, or other investments that have increased in value and you plan to donate to charity, donate the asset itself rather than selling it first and donating the cash. You avoid the capital gains tax on the appreciation and still get a charitable deduction for the full current value of the asset.

For example, if you bought a mutual fund for $10,000 and it is now worth $15,000, selling it first means you owe capital gains tax on the $5,000 gain. If you donate the fund directly to a may have access to charity, you owe no capital gains tax and can deduct $15,000 as a charitable contribution (subject to income limits on how much you can deduct in a year).

This works only with donations to may have access to charities recognized by the IRS. You cannot use this strategy with donations to individuals or political organizations. You will need a written appraisal of the asset's value if it is not publicly traded.

Use the step-up in basis for inherited property

When you inherit an investment, the cost basis (the price used to calculate your gain when you sell) is "stepped up" to the market value on the date of the person's death. This means if someone bought a stock for $10,000 and it was worth $50,000 when they died, your cost basis is $50,000, not $10,000. If you sell it shortly after for $50,000, you owe no capital gains tax.

This is one of the largest tax breaks available, but you have no control over it — it applies automatically to inherited property. It does not explore to property you receive as a gift during someone's lifetime; gifts keep the original cost basis.

The step-up rule has changed over time and may change again, so if you are planning your estate, consult a tax professional about how it may affect your heirs.

Manage your income to stay in a lower capital gains tax bracket

Capital gains tax rates depend on your total income. The 0% long-term capital gains rate applies if your income is below a certain threshold ($47,025 for single filers in 2024, higher for married filers). The 15% rate applies to income above that threshold up to a higher limit ($518,900 for single filers in 2024). Income above that is taxed at 20%.

If you are close to the edge of a tax bracket, timing when you realize gains can matter. For example, if you are a single filer with $45,000 in income and you have a $5,000 capital gain, the gain pushes you into the 15% bracket, and part of it is taxed at 15% instead of 0%. If you could defer $3,000 of the gain to the next year, you might keep more of it in the 0% bracket.

This strategy requires planning and is most useful if you have control over when you sell investments, such as if you are self-employed or retired and can choose which years to take withdrawals.

Frequently Asked Questions

Can I avoid capital gains tax by not selling?

Yes. As long as you hold an investment, no capital gains tax is due, even if it increases in value. Tax is owed only when you sell or exchange the asset. This is why some investors hold stocks for decades without paying capital gains tax.

What is the difference between short-term and long-term capital gains?

Short-term gains are from assets held one year or less and are taxed at your ordinary income tax rate, which is usually 10% to 37%. Long-term gains are from assets held longer than one year and are taxed at 0%, 15%, or 20% depending on income. Long-term rates are almost always lower.

Do I have to report capital gains if I did not sell anything?

No. Capital gains tax applies only to gains you actually realize by selling or exchanging an asset. Unrealized gains (increases in value while you still own the asset) are not taxed and do not have to be reported.

Can I use losses from one investment to offset gains from another?

Yes. You can net capital losses against capital gains in the same year. If losses exceed gains, you can deduct up to $3,000 of the excess against ordinary income, and carry forward any remaining losses to future years.

What happens to capital gains tax if I inherit an investment?

Inherited investments receive a step-up in cost basis to the market value on the date of death. This usually eliminates or greatly reduces the capital gains tax owed if you sell the investment shortly after inheriting it.