Personal Finance

How I Avoid Capital Gains Tax and How You Can, Too…If You Act Fast

Capital Gains Tax
Capital Gains Tax

Data source: IRS and author's illustrative example

That's right, if your family ends up in the 10% or 15% tax bracket, any long-term capital gains that you realize are completely tax free. I italicize "long-term" because if you don't hold your investments for at least one year, you (1) aren't investing very Foolishly, and (2) can kiss this major tax-advantage goodbye.

"Sure", you might argue, "but only the poor and those who can't invest fall in that tax bracket. This means nothing to me."

I understand that argument, but there are many more households that can benefit than you might think. Let's look at the maximum taxable income that will keep you in the 15% tax bracket.

Filing Status Upper Limit of 15% Bracket
Single $37,650
Married Filing Separately $37,650
Head of Household $50,400
Married Filing Jointly $75,300

Data source: IRS

If you live in a household that takes in $75,300, you're automatically in the top 40% of all U.S. households.

But it's about your taxable income

Here's where things start to get really interesting. Those maximum income figures are for taxable income; there's a host of deductions to be taken into consideration as well.

Let's take the average family of four with two parents and two children. If this family maxes out a health savings account and Traditional IRAs, here's what it looks like.

Deduction Type Amount
Exemptions ($4,050 per person) $16,200
Standard Deduction (Family) $12,600
Traditional IRA ($5,500 per adult) $11,000
Health Savings Account (Family) $6,750
Grand Total $46,550

That's enormous! Let's put this all together. If we know the taxable limit to stay in the 15% tax bracket (for a family of four) is $75,300, but we know that our example family can realize $46,550 in deductions, that means that the family's income could be as high as $121,800 before it wouldn't be able to use this strategy.

To put that figure in perspective, a household earning that amount would be in the top 20% of all U.S. households. In other words, as many as 80% of U.S. households could benefit from this strategy -- although that figure is admittedly inflated, as many households don't have enough money left over to invest in the stock market.

How to make this work in the real world

Because you still have a week left in the year, you still have time to take advantage of this capital gains tax loophole. I suggest you take the following steps.

  1. Figure out what your tax filing status will be (single, married filing jointly, etc.)
  2. Add up all of your incomes, and figure out what your deductions will be.
  3. If you have room left before hitting the 15% tax bracket ceiling, sell some of your long-term holdings from a regular taxable account.

Also, there's one thing that confuses many people: If you like the stock you sold, you can simply buy it back immediately after selling it. There's no wash-sale rule on capital gains , so you don't have to wait more than 30 days to repurchase it. That rule only affects capital losses . It's true that you'll pay two commissions, but the long-term tax savings make that minimal cost well worth it.

Before going off and making any wild moves, I strongly suggest consulting your tax professional. But hopefully, this article will give you an idea for how to plan your investing strategy to help your family benefit over the long run.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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