How to Reduce Capital Gains Taxes on Investments

10 Ways to Reduce Capital Gains Taxes on Investments

Capital gains taxes can take a significant bite out of your investment returns—especially if you’re a high-income earner or retiree managing appreciated assets. Fortunately, there are a variety of legal, IRS-compliant strategies to help minimize or defer those taxes, depending on your income level, investment type, and goals.

In this blog, we’ll explore 10 effective strategies to reduce capital gains taxes. 

1. Understand Short-Term vs. Long-Term Capital Gains

The first step in reducing capital gains taxes is understanding the difference between short-term and long-term gains. Short-term capital gains arise when you sell assets you’ve held for one year or less, and they’re taxed at your ordinary income tax rate. For high-income earners, this can mean a rate as high as 37%.

In contrast, long-term capital gains apply to assets held for more than one year and are taxed at preferential rates: 0%, 15%, or 20%, depending on your income bracket. Holding your investments just beyond the one-year mark can drastically lower your tax liability.

Example:

Let’s say you sell a stock you bought for $20,000 and it’s now worth $50,000. If you sell it after holding for 11 months, you could pay taxes of up to $11,100 (37% on $30,000). But if you wait another month and it qualifies as a long-term gain, your tax might be just $4,500 (15%).

External reference: IRS Topic No. 409 – Capital Gains and Losses

2. Harvest Capital Losses to Offset Gains

Tax-loss harvesting is a strategy where you sell investments that have declined in value to offset taxable gains elsewhere in your portfolio. This technique can significantly reduce your capital gains tax and lower your overall tax liability.

How it works:

• Gains and losses are netted against each other. If your gains exceed your losses, only the net is taxed.
• If your losses exceed gains, you can deduct up to $3,000 in capital losses against ordinary income each year.
• Any remaining losses can be carried forward to future years indefinitely.

This approach is most commonly used near year-end, but it can also be effective during market downturns. A key benefit is that it allows you to proactively rebalance your portfolio without triggering an excessive tax bill.

Warning: Be mindful of the wash-sale rule, which disallows a loss deduction if you repurchase the same or a substantially identical asset within 30 days.

3. Donate Appreciated Assets to Charity

If you plan to make charitable contributions, donating appreciated assets instead of cash is often a superior option. When you give stocks or mutual funds that have gained in value (and you’ve held longer than one year), you receive a tax deduction for the full market value without paying capital gains tax.

Why it’s powerful:

• The charity receives the full value of the asset.
• You avoid capital gains tax on the appreciation.
• You receive a charitable deduction for the fair market value of the donated asset.

This method works exceptionally well with a donor-advised fund (DAF), which allows you to make a large upfront donation, claim an immediate deduction, and distribute grants to charities over time.

4. Use the Step-Up in Basis at Death

One of the most valuable but often overlooked strategies is the step-up in basis rule. When an individual passes away, most appreciated assets in their estate receive a step-up in cost basis to their fair market value as of the date of death.

Why it matters:

• Heirs can sell inherited assets immediately with little or no capital gains tax.
• Assets that have appreciated significantly over decades are effectively “reset,” erasing the tax liability on gains accrued during the decedent’s lifetime.

This rule is especially impactful for family-owned real estate, long-held stocks, and investment portfolios. Incorporating this into estate and wealth transfer plans can preserve generational wealth and minimize tax exposure for heirs.

5. Invest Through Tax-Deferred or Tax-Free Accounts

Holding your investments in tax-advantaged accounts like IRAs and Roth IRAs is another excellent way to minimize capital gains tax. These accounts are designed to allow your money to grow either tax-deferred or tax-free, depending on the type.

Account types:

• Traditional IRA or 401(k): Taxes are deferred until you take distributions, which are taxed as ordinary income.
• Roth IRA: Contributions are made with after-tax dollars, but qualified withdrawals (including gains) are tax-free.

Placing growth-oriented assets (such as equity mutual funds or ETFs) in Roth accounts allows you to capture gains without triggering taxes—ever. This strategy is particularly useful in retirement income planning.

6. Time the Sale of Investments Wisely

Timing matters. Long-term capital gains tax rates are progressive and depend on your income. Being strategic about when to sell assets—especially those with large gains—can help you avoid paying higher rates.

Timing tips:

• Defer sales to lower-income years (such as the early years of retirement).
• Spread large gains across multiple tax years to avoid moving into a higher bracket.
• Coordinate with other income events, such as Roth IRA conversions or Social Security start dates.

Example: A retiree deferring Social Security and living off cash reserves may fall into the 0% long-term capital gains bracket—an ideal time to sell appreciated stock.

7. Use a 1031 Exchange for Investment Property

If you sell investment real estate, you can defer capital gains tax by using a 1031 exchange—an IRS provision that allows you to reinvest the proceeds into another like-kind property.

Key rules:

• You must identify the replacement property within 45 days of selling the original property.
• You must close on the replacement property within 180 days.
• The new property must be held for investment or business use.

1031 exchanges are powerful tools for real estate investors looking to upgrade properties or relocate holdings without triggering a tax bill. However, they are complex and require professional execution.

8. Invest in Qualified Opportunity Zones

Created under the 2017 Tax Cuts and Jobs Act, Qualified Opportunity Zones (QOZs) offer temporary tax deferral and potential exclusion of capital gains when investments are made through Qualified Opportunity Funds.

Benefits:

• Deferral of the original capital gain until December 31, 2026 (or earlier sale).
• Reduction of the deferred gain if held long enough.
• No tax on gains from the QOZ investment if held for at least 10 years.

This program encourages long-term investments in designated low-income communities and can be an attractive strategy for socially conscious investors seeking tax advantages.

9. Optimize Capital Gains with Bracket Management

Capital gains taxes are tiered based on income. Many taxpayers miss opportunities to realize gains tax-free or at lower rates simply due to poor income timing.

Planning strategies:

• Recognize gains in low-income years to stay within the 0% bracket.
• Offset capital gains with pre-planned charitable donations.
• Coordinate with retirement income distributions, such as RMDs and Roth conversions.
• Avoid spikes in Modified Adjusted Gross Income (MAGI) that could trigger Medicare IRMAA surcharges.

Bracket management is a proactive approach to smoothing income and avoiding steep tax cliffs.

10. Work With a Tax Advisor to Customize Your Plan

Each investor’s situation is unique. The strategies that work best for you will depend on your income level, investment mix, charitable goals, and estate planning objectives.

A tax advisor can:

• Analyze your specific portfolio and tax exposure.
• Design a multi-year tax mitigation plan.
• Help you navigate complex IRS rules and avoid mistakes.

 

Reduce Capital Gains Taxes With a Smarter Strategy

Capital gains taxes don’t have to be inevitable. With the right mix of timing, asset location, charitable giving, and long-term planning, you can control how much you pay—and when.

At WFP Tax Partners, we build customized tax strategies for investors, retirees, executives, and business owners who want to protect what they’ve built.

Contact us today to schedule a consultation and build a tax-efficient investment plan for 2025 and beyond.

 

 

FAQs

1. What is the capital gains tax rate in 2025?
   Capital gains tax rates in 2025 will remain tiered: 0%, 15%, or 20% for long-term gains, depending on income. Short-term gains are taxed at ordinary income rates, which can go up to 37%. Additional 3.8% Net Investment Income Tax may apply for high earners.
2. Can I avoid capital gains tax by reinvesting?
   In certain cases, yes. You can defer capital gains by reinvesting in like-kind real estate using a 1031 exchange or by investing in Qualified Opportunity Funds. These strategies are subject to strict IRS rules and deadlines.
3. What is a wash sale, and how do I avoid it?
   A wash sale occurs when you sell a security at a loss and repurchase it—or a substantially identical one—within 30 days. The loss is disallowed for tax purposes. To avoid it, either wait 31 days or buy a different asset with similar exposure.
4. Is it better to sell stock before or after retirement?
   Selling after retirement often results in lower capital gains taxes due to reduced income levels. However, the timing should align with your full financial picture, including Social Security, Medicare, and required withdrawals.
5. Are capital gains taxed in IRAs or 401(k)s?
   No. Investments within IRAs and 401(k)s grow tax-deferred (or tax-free in Roth accounts). Taxes apply only when you withdraw funds from traditional accounts.
6. Can I offset capital gains with other losses?
   Yes. Capital losses offset capital gains dollar-for-dollar. If losses exceed gains, you can deduct up to $3,000 against ordinary income per year, with the rest carried forward indefinitely.