Taking sales proceeds and buying new stock typically doesn't save you from taxes.
The primary goal of all investors is to make money on their investments. Once you're fortunate enough to earn a profit on an investment, however, you also have to do what you can to keep as much as possible out of the hands of the tax man. With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.
Special tax provisions don't apply to stock
The Internal Revenue Code is full of provisions that allow people to take proceeds from sales of property and reinvest it without having to recognize capital gain. The most popular is in the real-estate industry, where so-called "1031 like-kind exchanges" make it possible for owners to swap properties without any tax consequences. Similarly, in the life insurance industry, what are known as "1035 exchanges" allow policyholders to switch from one life insurance policy or annuity policy to another without having to pay capital gains tax on the paper profits from the policy being swapped out.
No such provisions apply to sales of stock in taxable accounts. Taxpayers have to recognize all of their capital gains. If they've owned the stock for a year or less, then they'll pay short-term capital gains tax at their ordinary income tax rate on the profit. If they've held the stock for longer than a year, then the lower long-term capital gains tax rates will apply.
How to avoid capital gains tax
The fact that there's no way out of paying tax on reinvested gains is one key reason why tax-favored retirement accounts are so popular. Within an IRA, 401(k), or other tax-favored retirement account, you can make sales of stock or other investments without any immediate tax consequences at all. You can then reinvest those proceeds in new stock. Only once you make withdrawals from your retirement account will tax issues come into play.
For your taxable account, though, your best defense against capital gains taxes is to be a long-term investor. You don't have to recognize capital gains on stock until you sell, so that gives those who invest in companies they're comfortable holding for years or even decades a leg up on short-term traders, who will end up paying a much higher tax burden.
Some argue that reinvesting gains from stock sales should be tax-free. Lacking major reform, though, investors should simply take steps to minimize the number of sales that force them to recognize such gains. Click here to compare brokers and choose the one that offers the most benefits for your investing style.
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FAQs
Capital gains generated by funds held in a taxable account will result in taxable capital gains, even if you reinvest your capital gains back into the fund. Thus, it may be smart not to reinvest the capital gains in a taxable account so that you have the cash to pay the taxes due.
Can I avoid capital gains tax if I reinvest? ›
Reinvest in new property
The like-kind (aka "1031") exchange is a popular way to bypass capital gains taxes on investment property sales. With this transaction, you sell an investment property and buy another one of similar value. By doing so, you can defer owing capital gains taxes on the first property.
Are capital gains taxed if they are reinvested? ›
The taxpayers can minimize or avoid paying tax by reinvesting capital gains from residential house property under the Income Tax Act, 1961. The taxpayer can either reinvest the capital gains in bonds or in a residential property. The taxpayer needs to fulfil a few conditions in both of the options to gain tax benefits.
Do you pay taxes twice on reinvested dividends? ›
The IRS considers any dividends you receive as taxable income, whether you reinvest them or not. When you reinvest dividends, for tax purposes you are essentially receiving the dividend and then using it to purchase more shares.
Does selling stock and reinvesting it count as income? ›
The reason is that you still made money from selling the stock, which constitutes taxable income. The fact that you chose to reinvest the money doesn't mean it isn't taxable income, any more than using the money any other way would mean it isn't taxable.
What is a simple trick for avoiding capital gains tax? ›
An easy and impactful way to reduce your capital gains taxes is to use tax-advantaged accounts. Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes at all on the assets in the account.
What is the 6 year rule for capital gains tax? ›
The capital gains tax property six-year rule allows you to treat your investment property as your main residence for tax purposes for up to six years while you are renting it out. This means you can rent it out for six years and still qualify for the main residence capital gains tax exemption when you sell it.
How to reinvest profits to avoid tax? ›
7 ways to minimize investment taxes
- Practice buy-and-hold investing. ...
- Open an IRA. ...
- Contribute to a 401(k) plan. ...
- Take advantage of tax-loss harvesting. ...
- Consider asset location. ...
- Use a 1031 exchange. ...
- Take advantage of lower long-term capital gains rates.
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
How to avoid capital gains tax on stocks? ›
9 Ways to Avoid Capital Gains Taxes on Stocks
- Invest for the Long Term. ...
- Contribute to Your Retirement Accounts. ...
- Pick Your Cost Basis. ...
- Lower Your Tax Bracket. ...
- Harvest Losses to Offset Gains. ...
- Move to a Tax-Friendly State. ...
- Donate Stock to Charity. ...
- Invest in an Opportunity Zone.
It May Take Longer To Achieve Long-Term Financial Goals: Dividend reinvestment leads to compounded growth. This makes it easier (and faster) to achieve your long-term financial goals versus keeping cash in a savings account.
How do you avoid double taxation of dividends? ›
Retain earnings: If the corporation doesn't distribute earnings as dividends to shareholders, earnings are only taxed once, at the corporate rate. Pay salaries instead of dividends: Shareholders who work for the corporation may be paid higher salaries instead of dividends.
When to stop reinvesting dividends? ›
There are times when it makes better sense to take the cash instead of reinvesting dividends. These include when you are at or close to retirement and you need the money; when the stock or fund isn't performing well; when you want to diversify your portfolio; and when reinvesting unbalances your portfolio.
Can you avoid capital gains tax on stocks by reinvesting? ›
Yes, you will have to pay tax on stock gains even if you reinvest. However, how much you will have to pay can vary, depending on how long you've held the stock, and your income level. You can also participate in tax-loss harvesting by selling other stocks in your portfolio at a loss to offset your total tax burden.
How long do you have to reinvest to avoid capital gains tax? ›
Frequently Asked Questions about Capital Gains Tax
As long as you sell your first investment property and apply your profits to the purchase of a new investment property within 180 days, you can defer taxes.
How can I reduce my capital gains tax? ›
How to Minimize or Avoid Capital Gains Tax
- Invest for the Long Term. You will pay the lowest capital gains tax rate if you find great companies and hold their stock long-term. ...
- Take Advantage of Tax-Deferred Retirement Plans. ...
- Use Capital Losses to Offset Gains. ...
- Watch Your Holding Periods. ...
- Pick Your Cost Basis.
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
How can I avoid capital gains tax without a 1031 exchange? ›
Utilizing a Deferred Sales Trust, investors can defer capital gains taxes over time. Deferred Sales Trusts provide an alternative to 1031 exchanges for deferring capital gains taxes on appreciated assets.
