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Tthe end of the year is a time for reflection, and this also applies to your investment accounts. Many people choose to rebalance their portfolios at the end of the year, so it’s especially important to know the effect of your trading actions on your upcoming tax bill in April.
Below are three easy-to-apply strategies to reduce or even eliminate any potential capital gains tax in 2021.
1. Tax loss
If you have losses in your taxable brokerage account, you can offset them with gains to avoid capital gains tax. First, you will need to account for net gains and losses of the same type. For example, short-term gains can only be deducted from short-term losses, and long-term gains can only be deducted from long-term losses. From there, you’ll calculate the total again to get a final number that will be reported on your tax return.
This is probably best illustrated with a digital example. Suppose you have $ 5,000 in short-term losses for the year (that is, you bought a stock earlier this year and its value has lost $ 5,000). At the same time, you have another stock that you bought earlier in the year that has increased in value by $ 2,000.
If you sold both stocks, you would lock in a short-term loss of $ 5,000 and a short-term gain of $ 2,000, leaving you with a short-term net capital loss of $ 3,000. Fortunately, not only would you avoid paying tax on the stocks that generated a gain, but you could also deduct the short-term capital loss of $ 3,000 as a deduction from ordinary income on your tax return.
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2. Rebalance retirement accounts
When you rebalance your taxable brokerage account, you will pay tax on any realized gains. For example, if you buy a stock that has gone up in value and then sell it, the IRS will come knocking on the door. However, there is another story if you are trading your retirement accounts.
Because popular retirement vehicles [like Roth IRAs, 401(k)s, and 403(b)s] are tax-advantaged accounts, you will only owe tax when you contribute or when you exit when you finally receive a distribution. This allows you to trade freely in your retirement accounts without fear of capital gains tax – short or long term.
If you have a financial plan that includes semi-annual rebalancing, it is to your advantage to rebalance in a retirement account where you know there is no real downside to reallocating your money. Knowing this, you can be more thoughtful when realigning your predetermined asset allocation.
3. Do nothing
Leaving your investments alone, regardless of their performance, is a proven strategy for paying no capital gains tax. Even though your investments have appreciated generously this year (and it is possible, given the more than 20% gain of the S&P 500 in 2021), there is no reason to change what worked for you, to unless you need the money now.
Alternatively, you can defer sales of investments to 2022, which would push any potential capital gains tax due until 2023. This is an effective strategy if you already have a hefty tax bill coming in April or if you have no losses this year to compensate. wins. Here you would still be liable for tax but would have the advantage of a longer trail to finally pay it.
Learn the rules first
If you know the basic rules about capital gains tax, you can work to minimize it, even as your investments increase. As your income and assets increase over time, the value of knowing the details will also increase. It’s all about intentionality: if you’re very wise about every transaction you make, you’ll be in a much better position to deal with the IRS.
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