3 Effective Strategies to Reduce Capital Gains Tax

It’s a known fact that whatever amount you earn, the government would want a percentage of it. This is mostly true in case of all the democratic societies. Similarly, the government would also want a share when you make a profit on your investments. This share is called ‘capital gains tax’.

It’ll be quite helpful for the purpose of taxation to understand what is realized and unrealized gains. A realized gain is when you sell your investment or asset at a profit. On the other hand, an unrealized gain refers to a potential profit. This is something which exists on paper, but you haven’t yet cashed it out. An individual has to pay the capital gains tax only when the asset or investment is sold.

In the United States, the long-term investors benefit greatly from the country’s tax system. You’ll have to pay a higher rate of tax on the short-term investments. There are some effective strategies that you can employ for reducing your capital gains tax:

1. Having a Roth IRA account

IRA is an acronym for Individual Retirement Account. A Roth IRA account allows qualified withdrawals that are tax-free. However, this is subject to certain conditions. This account is quite similar to the traditional IRAs. The difference between these two accounts is the way they are taxed. Besides, Roth IRA is less restrictive than the other types of accounts.

You’ll have to pay income tax when you withdraw money from the traditional IRAs during retirement. The only condition is that you must follow certain rules associated with it. One of them is that you must be at least 59 years and six months old. Second is that it must be at least five years since you first contributed to your Roth IRA.

2. Making long-term investments

If you’ve purchased the stocks of some great companies, you must hold them for the long term. This is because you’ll then pay the lowest rate of capital gains tax. Unfortunately, this is easier said than done. The company’s fortunes can change over a period of time.

Besides, you might want to sell the stocks earlier than you had planned. This is usually when it hits a certain price target that you’ve wanted. You might also want to sell when you see the fundamentals of the company deteriorating.

3. Offsetting gains using your capital losses

If you’re experiencing an investment loss, you can use it to your advantage. This is with regards to the gains that you might be making on other investments. Using the loss you’re making on some of your investments, you can decrease the capital gains tax. For example, let’s take a scenario where you own two stocks. One is currently worth 15 % more than you paid for it and the other is worth 10% less.

Upon selling both the stocks, the loss you make on one would reduce capital gains tax on the other. Of course, all your investments would appreciate in an ideal situation, but losses can happen. If your capital losses are more than your capital gains, you’d benefit from it. You can utilize up to $3,000 of it for offsetting your ordinary income for the year.

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