How can I Avoid Capital Gains Tax?

Most monetary transactions are subject to some kind of tax in the United States. This is something that an investor must be especially aware of when it comes to planning how and when to purchase or sell an asset. The tax rates on capital gains vary depending on how long the asset was held for, and where the taxpayer lives. There are some ways to actually avoid capital gains taxes, or at least reduce the tax burden that one has to pay. These include taking advantage of loopholes that are written into the tax laws at the state and federal levels.

There are two main areas of the average person’s finances where capital gains taxes would be a concern. The first is at the time of the sale of stocks or other securities. There are only a few tax loopholes left that allow a person to partially avoid taxes incurred by selling stocks that have appreciated, and these loopholes are among the least publicized in the tax code. One of them, which is especially helpful for parents with children in college, is to give appreciated stock to their children to pay for their schooling. While it’s impossible to avoid capital gains taxes altogether, their children pay the tax at the lowest rate, 5%.

It’s important to keep a few things in mind when using the above tax loophole. First, someone can only give $11,000 U.S. Dollars (USD) per year worth of stock to his children without that transaction itself being taxed. Secondly, once the stock is given to the child, he is the legal owner of it. This means that if he decides to cash out the stock and buy a car, for instance, instead of paying for his education, there isn’t much the parent can do to prevent it. This may be avoided if the parent sets up a brokerage account in the child’s name while retaining full trading authority. Such may be a wise choice for a parent looking to safeguard the child’s educational funds.

The other time when the average person might want to avoid capital gains taxes would be at the sale of a piece of real estate. If a property increases in value from the time it was bought until the time it was sold, that sale is subject to capital gains taxes, but tax loopholes exist in these situations as well. One well known loophole is called a 1031 exchange, or Starker Trust exchange. In this type of exchange, an investor sells a property, then buys another that is worth more, within a certain time frame. If this is done correctly, the investor can avoid paying capital gains taxes on that transaction for the time being.

Another loophole exists for an investor who lives at an investment property for at least two of the five years preceding the sale of the property. That investor may be able to avoid paying taxes for up to $250,000 USD worth of appreciation on the property. Loopholes such as these are purposely written into the tax code for the benefit of investors in certain situations, and it is important to stay within the boundaries set by tax laws. There are also tax shelters that are illegal, and these should be avoided since their use constitutes tax evasion, a serious crime. Legal tax avoidance, however, can be a valuable tool for an investor seeking to lessen his tax burden.