In 2014, federal tax revenue in the US exceeded $3 trillion for the first time in history.
That same year, nearly $140 billion was paid out in capital gains tax. This was also the highest figure that had ever been collected.
Taxes are important to keep our country running. But capital gains tax can have a serious impact on your own personal financial situation. The good news is that there are ways around it.
So read on as we take a look at how to avoid paying capital gains tax.
What Is Capital Gains Tax?
Capital gains tax is a payment you make to the government when you sell an asset for more than you paid for it.
The most common example is selling your house. If you bought it for $200,000 and sold it for $300,000, you’ve made a capital gain of $100,000. And the government wants a piece of it.
As well as real estate, it also applies to other assets such as automobiles and stocks and bonds.
How Much Do You Have to Pay?
The amount of capital gains tax that you will be liable for depends on a number of factors.
But one of the most important is how long you have held the asset for. Depending on how recently you bought it, you will either be liable for short or long term capital gains.
Short Term Capital Gains
Short term capital gains are taxed at the same rate as your other income.
So if you sell an asset within twelve months of buying it, any profit you make on it will incur capital gains tax at your ordinary tax rate. This will be somewhere between 10% and 37% depending on your other earnings.
The twelve-month cut off starts from the day after you purchase the asset up to and including the day that you sell it.
Long Term Capital Gains
If you hold on to an asset for more than a year, then it will fall under long term capital gains.
The maximum you will pay for long term capitals gains tax is currently 20% and you need to have a taxable income of well over $400,000 to reach that bracket. For the vast majority, the rate will be 15%. And for those whose taxable income is less than $39,375 for a single filing, you won’t pay any capital gains tax at all.
How to Avoid Paying Capital Gains Tax
If you’re concerned that capital gains tax could leave you with a hefty sum to pay, there are steps you can take.
These are perfectly legal ways to reduce the amount of tax you will have to pay. You may even be able to remove any capital gains tax liability at all.
Lower Your Tax Bracket
As we have already seen, the amount of capital gains tax you will pay is dependent on your total taxable income.
So for example, if you were selling an asset that would take your taxable income over $39,375, you will eligible to pay capital gains tax at the 15% level on anything above that. But if your total taxable income falls below that level then you will have no capital gains tax to pay at all.
Sell Your Primary Residence
Everybody needs somewhere to live.
The government recognizes that most of us will sell our home in order to buy another home. So if you are selling your primary residence, individuals can make a net profit of $250,000 without being liable for any capital gains tax. For married couples, the exclusion covers the first $500,000.
In order for a property to be classed as your primary residence, you need to have lived in it for at least two of the five years prior to its sale. The two years doesn’t have to be consecutive. If you’ve lived in your home for two years, but haven’t owned it for five, it may be worth renting it out until you are no longer liable for capital gains.
If you’re selling an investment property, you won’t be able to use the primary residence exclusion.
But there are still ways to avoid capital gains tax. You’ll need to use the proceeds of the sale of your rental property to purchase another similar investment within 180 days. This would then exempt you from capital gains tax.
This technique is known as a 1031 exchange, after the section of the tax code that relates to this exemption. The rules can be pretty complex, so it’s worth speaking to a professional if you’re considering a 1031 exchange.
Keep Track of Your Home Improvement Spend
The total cost of your property doesn’t just include the price you paid for it.
It also includes any money that you have spent on home improvements. So if you’ve shelled out for things like new windows, landscaping or even air conditioning this can all be deducted from the net profit when you sell.
Make sure that you keep all of the receipts for any home improvements that you make. You will need them for when you come to submit your tax return.
Qualify for a Partial Exclusion
You may qualify for a partial exclusion of capital gains tax if you meet certain criteria.
For example, if you were transferred to a new job at least 50 miles further away than your previous work location. Or if you did not previously work and have started a new job that is 50 miles from your home. In both cases, you are eligible for a partial exclusion because you are selling your home in order to be closer to work.
The same applies if you are forced to move for health-related reasons. This includes if you sell up and move in order to get treatment for a disease or injury for yourself or a close family member.
Do You Want to Learn More About State and IRS Taxes?
Now that you know how to avoid paying capital gains tax, you may have other questions about taxation.
We’re here to help. We have a ton of great content covering everything you wanted to know about taxes. The articles cover everything from personal taxes to business taxes, and IRS audits to tax debt relief.
Feel free to take a look around.