How to Avoid Capital Gains Taxes on Stocks

Seeing your stock investments rise and pocketing the profit might feel like living the dream. But that excitement could quickly slip away when the IRS hits you with capital gains tax. If you aren’t careful, you could get taxed at a higher rate.

If you sold stocks this year, you have a few options for trying to lower capital gains taxes. You hold your investments for the long term, lower your bracket, donate to charity, move to a tax-friendly state, trade through your retirement account, offset losses against gains and harvest tax gains.

Avoid overpaying your capital gains tax on stocks with some advanced planning.

How Capital Gains Taxes Work 

You have a capital gain when you sell stock for more than you paid. When you file your return, you report and pay tax on the net capital gains you realized for the year.

Taxes on stock sales can get tricky. Your tax rate depends on how long you owned the shares before selling. You have a short-term gain when you sell the stock you have owned for less than one year, for example, if you’re day trading. You have a long-term gain when you sell stock or investments like real estate that you have owned for over a year.

Higher ordinary income tax rates apply to short-term gains. However, lower capital gains tax rates apply to long-term gains.

When Do You Have to Pay Taxes on Stocks?

You only pay tax on stocks when you sell them at a gain. So even if the value of your stock rises, you don’t owe capital gains tax unless you sell your shares. 

Long-Term Capital Gains Tax on Stocks

Lower tax rates apply to long-term capital gains than short-term gains. The long-term capital gains tax rates range from 0% to 20%. Your rate depends on the filing status and taxable income reported on your tax return. 

Long-Term Capital Gains Tax Rates for 2023 (Due April 2024)

Long-Term Capital Gains Tax Rates for 2024 (Due April 2025)

Short-Term Capital Gains Tax on Stocks

Short-term capital gains are taxed at ordinary income rates. Depending on where you land on the federal income tax bracket, you could pay up to 37% tax on short-term gains. 

Short-Term Capital Gains Tax Rates for 2023 (Due April 2024)

Short-Term Capital Gains Tax Rates for 2024 (Due April 2025)

Capital Gains Tax by State

States have their own taxation rules. Depending on where you live, you could owe state taxes on stock gains.

States that charge no tax on capital gains or earned income are listed below:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Wyoming

Other tax-friendly states for capital gains include:

• North Dakota – 2.9% rate, can exclude 40% of capital gains from income
• Indiana – 3.15%
• Pennsylvania – 3.07%

How Can I Avoid Capital Gains Tax on Stocks?

You can avoid, or at least reduce, your capital gains tax with a little planning. Below are seven ways to take the bite out of capital gains taxes. 

1. Hold investments for the long term

If you sell appreciated stock you have owned for less than one year, not only will you pay ordinary income rates based on a lower income threshold. When possible, try to hold your stock investments for at least a year before selling. Depending on your income, you could avoid tax altogether. Even if you exceed the income bracket's threshold, you pay tax at a lower capital gains rate. 

2. Lower your tax bracket

Your taxable income determines your tax rate on stock gains. You can make some strategic moves to lower your income before the end of the year. For example, maximizing deductions if you itemize can lessen your tax burden. Consider bumping up your charitable contributions or prepaying property taxes before the year-end. 

Or, you can lower your income by maximizing contributions to your retirement and health savings accounts. 

3. Donate stock to charity

If you have stock worth more than what you paid, you can avoid capital gains tax by donating it to charity. Plus, you can deduct the current value of the shares, instead of what you paid, as a charitable contribution if you itemize. 

4. Move to a tax-friendly state

You could owe federal and state taxes when you sell stock at a gain. However, you can avoid paying taxes at the state level when you live in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. None of these states charge capital gains taxes. 

5. Trade through your retirement account

You avoid capital gains tax when you buy and sell stock through your retirement account. Remember that if you have a traditional 401(k) or IRA, you pay ordinary income tax rates on the money you withdraw in retirement. You may still come out ahead if you are in a low tax bracket and live in a state that doesn't charge tax on retirement income.

If you buy and sell stock through a Roth 401(k) or IRA, you avoid tax altogether when you withdraw money in retirement. 

6. Offset gains and losses

You can lessen your tax burden by offsetting capital losses against capital gains. So, if you have stock valued less than what you paid, consider selling your shares to offset capital gains. Just be mindful of the classification. You can only offset long-term capital losses against long-term capital gains and short-term losses against short-term gains. 

7. Harvest tax gains

If you change jobs, take a leave of absence or retire, your earnings may be lower than usual. You could avoid paying capital gains tax if you sell appreciated stock in a year with lower income.

Plan Stock Sales to Minimize Capital Gains Taxes

When you plan to sell appreciated stock, you can implement many strategies to minimize the tax bite. You can take proactive steps and hold onto more of your money. Speak with a personal financial adviser to plan your capital gains strategy. 

Frequently Asked Questions