Eliminate, Minimize, Or Defer Paying Taxes On Your Stock Gains
I want to get right to the point today and discuss how to avoid capital gains tax on stocks paying dividends.
I’m going to emphasize 10 ways that most dividend investors can go about it. Plus, I will throw in a couple more advanced strategies at the end.
Because who wants to pay more taxes than necessary? I know I don’t.
So, let’s get moving…
10 Ways To Avoid Capital Gains Tax on Stocks That Pay Dividends
Whether you invest in dividend-paying stocks or growth stocks that do not.
Either way, you can eliminate, minimize, or defer capital gains taxes by using any one or all of these 10 techniques…
- Hold your stocks in a qualified retirement account
- Minimize your taxable income
- Give away your appreciated stock
- Hold appreciated stock until death
- Practice tax loss harvesting
- Use capital losses to offset capital gains
- Use specific identification when you sell shares
- Move to a state with no income tax
- Hold stocks for the long term to reduce turnover
- Invest in dividend stock funds with low turnover
Next, let’s go through each of these 10 points about capital gains taxes on stocks one by one…
Disclosure: At no cost to you, I may get commissions for purchases made through links in this post.
…starting with 4 ways to eliminate capital gains taxes on stocks...
1. Hold Your Stocks In A Qualified Retirement Account
Buying and holding dividend stocks for qualified retirement accounts has many advantages. And eliminating capital gains taxes is just one of them.
Avoiding Capital Gains Tax On Stocks Held In A Roth IRA
First, tax-advantaged retirement accounts include the Roth IRA.
With a Roth, you pay ordinary income tax on the earnings from your job. Then you make contributions to your Roth account up to specified annual limits from those after-tax earnings.
After that, you never have to pay taxes on your Roth account.
Whether you leave the money in the account or withdraw it. Thus, short-term and long-term capital gains on stock held in a Roth are tax-free.
Avoiding Capital Gains Tax On Stocks Held In Traditional Retirement Accounts
Second, there are traditional retirement accounts. Such as 401(k) plans and traditional IRAs.
With these accounts, you get your tax break up front.
This means some of the money you make from your job during a given year is tax-free up to specified limits. As long as you deposit it in your retirement account.
However, when planning for retirement. Know that when you withdraw your funds, taxes are due.
But all withdrawals are taxed as ordinary income. Not taxed as capital gains.
Thus, you can’t avoid paying income taxes. But you aren’t paying capital gains taxes in this case.
As a result, if your primary goal is to eliminate taxes on investment gains. Stick with a dividend retirement strategy that emphasizes a Roth IRA.
Finally, tip number 1 just discussed, stands alone. As it pertains to holding your stocks in a qualified retirement account. I started here because maximizing these accounts for minimizing taxable income is a “no brainer”.
On the other hand, the rest of today’s ways to avoid capital gains tax on stocks. They apply to stocks held in your taxable accounts.
That’s where capital gains tax planning and tax strategy come into play. So, let’s keep moving…
2. Minimize Your Taxable Income
Below specified levels of taxable income, long-term capital gains rates on stocks are zero!
First of all, to qualify for the long-term status you must hold your stock for at least one year.
Furthermore, the amount of taxable income you can not exceed depends on your filing status. Which will fall into one of these 4 categories:
- Single
- Married filing jointly
- Married filing separately
- Head of household
Furthermore, the maximum income level increases every year. Since it is indexed for inflation.
Thus, I can’t give you specific guidance on whether or not you will qualify. Various publications including the IRS lay out the income limits by filing status.
Better yet, consult with your tax advisor. To see if there are ways to stay within the taxable income requirements.
Because if you can, you will completely avoid capital gains tax on stocks! Whether your stock holdings pay dividends or not.
Okay. We are just getting warmed up.
Next up, just by being generous, you can avoid long-term capital gains tax…
3. Give Away Your Appreciated Stock
Because there are a couple of ways to go about giving away stock to avoid capital gains…
Avoid Capital Gains Tax On Shares By Giving Appreciated Stock To Charity
First, give your appreciated stock to a qualified charity. Then you won’t have to pay capital gains tax. You also may qualify for a nice tax deduction.
Avoid Capital Gains Tax On Shares By Giving Appreciated Stock To ANYONE
Second, the Internal Revenue Service allows you to give away a certain amount of money (or stock) each year to anyone. And the individual or individuals do not have to be qualified charities.
Yes, you can give appreciated stock to a child, parent, friend, or total stranger. And you can do so for as many people as you choose.
As of the date of this post, the annual amount is $16,000. However, tax laws generally increase this value over time.
As a result, you the donor will pay no capital gains tax.
But the recipient will inherit your cost basis. Thus, when they go to sell, they may have to pay capital gains tax.
This is an especially desirable financial result if you give the stock to someone who has little or no income. Because they may qualify for the zero capital gains tax rate. See point number 1 above.
Regular readers know that I’m a long-term investor. Since I like to buy and hold my dividend stocks forever. Maybe this next point takes my investment philosophy a little too far.
I don’t know. That’s for you to decide.
However, it’s another way to avoid tax on stock gains…
4. Hold Appreciated Stock Until Death
Just hold your appreciated stock until you die.
Because you won’t pay capital gains tax during your lifetime. And whoever you choose to inherit the stock receives what is known as a stepped-up basis.
Therefore, the beneficiary’s cost basis in the stock is “stepped up” to fair market value. It is the value on the day of the owner’s death.
Thus, the beneficiary can sell the shares and not owe capital gains taxes. Unless the shares have appreciated even more since the original owner’s date of death.
This tax law is especially beneficial for dividend stocks. Because the original owner can enjoy cash flow from the investment while they are alive. Without having to sell the shares and incur capital gains taxes.
Okay. That concludes 4 ways to eliminate capital gains taxes as the owner of appreciated stock.
As a reminder, all of the techniques I’m describing today apply to dividend stocks. And stocks that do not pay dividends too.
Furthermore, you can get great recommendations on the best stocks to invest in. For this, I like the Motley Fool Stock Advisor.
Next, I would like to cover 4 ways to minimize capital gains tax on stocks. For those times when eliminating them is just not possible.
This is exactly how I avoid paying taxes when I sell stock…
5. Practice Tax Loss Harvesting
Tax loss harvesting is the act of selling shares that have declined in value from the original purchase price. Thus taking an unrealized loss and turning it into a realized one for tax purposes.
I have used this technique frequently over the years. Here’s how I like to go about it…
My Method Of Tax Loss Harvesting To Avoid Capital Gains Tax On Stock
First, when the stock market goes down by a lot in the short term, I look through my portfolio of dividend stocks. Identifying those that are worth less than what I paid for them.
Second, I classify these stocks into two categories. Those that I wish to no longer own. And others that I want to keep long-term.
For the first group, I sell and take a loss. And look for new and different stocks to invest the proceeds into.
While for the second group, I sell and set a date to purchase back the shares.
However, there are a couple of things to be careful of…
Use Caution When Tax Loss Harvesting To Minimize Capital Gains Tax
First, I slowly and methodically sell one or two stocks at a time. Because I don’t want to sell off a big chunk of my portfolio and miss a stock market rally.
So, this investment approach works especially well in long protracted bear markets. Because sometimes you can buy back your shares at a lower price.
Second, for the stocks, I want to sell and buyback. I make sure to wait at least 30 days after I sell the shares.
Because if you buy the stock back any sooner, the IRS disallows the loss. This is called the wash sale rule.
How To Use Harvested Tax Losses To Reduce Your Capital Gains Taxes
During the bear market of 2007 to 2009, I methodically applied this investment guidance. And built up a large inventory of realized tax losses.
First, I used the allowable amount of losses to reduce my taxable income. Based on current tax law, you can do this for up to $3,000 each year. Until all of your losses are used up.
Using the losses as just described can take a long time. Or, execute strategy number 6 to avoid long-term capital gains tax on stocks…
6. Use Capital Losses To Offset Capital Gains
Because a taxpayer can use their inventory of capital losses on stocks. Doing so to directly offset any realized capital gains.
It’s as simple as that. To sum it up…
Look for capital losses on stocks in the portfolio. Strategically sell shares to realize those losses.
Reinvest the proceeds. But watch out for the wash sale rule.
Use the losses to offset $3,000 of your ordinary income each year. A great tax savings strategy.
Also, to offset realized capital gains on current and future stock sales.
Continue this process until your inventory of capital losses is used up. Sometimes it can take more than one year to do so.
The hope is, that you and I won’t incur losses on our dividend stocks portfolios. At least not over the long term.
Furthermore, I like to put the odds for success in my favor. For this, I use and recommend the Simply Investing Report and Analysis Platform.
Simply Investing helps you identify the best dividend stocks. And the right time to buy them.
Because generating dividends and capital gains are good problems to have!
However, bear markets do occur. Stocks do go down, sometimes by a lot. It is during these times that you can “turn lemons into lemonade” as the saying goes.
Thus, avoiding capital gains tax on stocks. As your move forward through your life as an investor.
Next, tip number 7…
7. Use Specific Identification When You Sell Shares
Many investors like you and I add to our stock positions over time. There are several ways to go about this…
First, by practicing dollar cost averaging into dividends stocks.
Second, by implementing the pyramid technique to buy stocks. This means making at least 2-3 smaller incremental purchases to build your position over time.
Third, by regularly reinvesting your dividends.
In any of these cases, sometimes you will buy when share prices are higher. Sometimes your purchases happen when stocks are lower.
So, when you go to sell a portion of your shares in a stock. Say, to rebalance your portfolio.
Be sure to use the specific identification method for identifying the shares sold. And pick the shares that cost the most. Thus having the highest cost basis.
At a minimum, this will reduce your capital gains tax. And perhaps some of your shares will reflect a loss.
As we know from numbers 5 and 6, just discussed. Those losses have value as you look to avoid stock capital gains tax.
Moving right along, and I do mean moving!
8. Move To A State With No Income Tax
So far, we have been talking about Federal income taxes applied to your capital gains. However, the states have their hands out too. Depending on where you live.
Thus, by moving to a no-tax state. You can eliminate state taxation on your realized capital gains. For reference, the states that do not charge residents income taxes are:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Here are a couple of ways you can go about it…
First, let’s say you own a condo in Florida where you spend the winter months. While enjoying your summers back in your home state. For sake of argument, let’s say Minnesota.
If you can prove your primary home is in Florida. Then you can stop filing and paying taxes in Minnesota. Thus, taking advantage of Florida’s zero individual income tax.
Second, maybe you have jumped on the latest trend and have become a remote worker. No longer tied to a physical workplace.
Then, pick up and move to a no-tax state. Thus, avoiding state-level capital gains taxes. Better yet, state income taxes of any kind.
Depending on how much money you make. The tax savings can add up fast.
Okay. That concludes 4 ways to minimize capital gains taxes on stock. If you can’t eliminate them as discussed in the first 4 points in today’s article.
The final two points serve as ways to defer capital gains taxes. Let’s go through them now.
9. Hold Stocks For The Long Term To Reduce Turnover
I attempt to operate like a successful long-term investor for many reasons. And preach that philosophy to anyone who will listen.
As a result, this rule is pretty simple for me. If you don’t sell your stocks. Capital gains remain unrealized. And unrealized capital gains are not taxed.
Only when you sell and realize a gain do capital gains taxes come into play.
Many of us invest long-term to fund retirement. So, we buy high-quality stocks. Some of which may pay dividends.
And we hold them as long as possible. Perhaps only selling to raise cash during retirement years.
To summarize this point: get invested and stay invested in stocks!
10. Invest In Dividend Stock Funds With Low Turnover
And the same concept applies if you choose to invest in stocks through the best mutual funds.
First, buy and hold funds for the long term. Second, choose funds with low turnover.
Because if a fund you own sells appreciated stock within its portfolio. It is required to pass your portion of the capital gain on to you as the fund investor.
Thus, funds that employ high-turnover trading strategies can surprise you with taxable capital gains. So, stick with low-cost index funds. Because they trade very little.
Okay. That concludes my 10 tips to avoid paying capital gains tax on stocks.
However, there are a couple of different investment strategies that I will touch on next.
They tend to be more complex. And not applicable to average investors like you and me.
Other Strategies To Avoid Long-Term Capital Gains Tax on Stocks with Dividends
As I said, these programs and tax policies go beyond the needs of most individual investors.
I include them here to cover all the bases on this investment topic. They are unlike points 1 through 10. There I have many years of direct hands-on do-it-yourself investing experience.
So, I have included links to authoritative guidance if these areas are of interest to you. For avoiding capital gains tax on stocks…
Invest In Opportunity Zones To Avoid Capital Gains Tax On Stocks
There are several tax benefits from this law. It was put into place to encourage investment in low-income distressed communities that need funding and development, called opportunity zones.
Invest In Qualified Small Businesses (QSBS) To Avoid Capital Gains Tax On Stocks
The qualified small business stock exclusion is a tax break that applies to eligible shareholders of a qualified small business.
It was put into place to encourage people to take the risks involved with founding, investing in, and going to work for a startup.
Okay. That’s enough about these 2 more complex strategies. And taxes in general for today.
So, allow me to wrap up with a few parting comments…
Now You Know How To Avoid Capital Gains Tax on Stocks
There are several golden rules to investing. Such as…
Adopt an investment strategy consistent with your risk tolerance. That is also suitable for your achieving your investment goals.
Understand what you are investing in. And invest for the long-term.
Keep investment costs low. While also minimizing taxes.
Today’s article focused on the last point. Specifically, eliminating, minimizing, or deferring capital gains tax on stocks.
By using 10 tried and true techniques that work both individually and collectively to minimize taxes on your investments.
Thanks for reading. And if you liked this article, check out all of our…
Posts about Getting the Most from Dividend Stocks
Avoiding Capital Gains Tax On Stocks – Conclusion And Housekeeping…
Author Bio: Tom Scott founded the consulting and coaching firm Dividends Diversify, LLC. He leverages his expertise and decades of experience in goal setting, relocation assistance, and investing for long-term wealth to help clients reach their full potential.