Tax Deferred – 3 Ways to Avoid Capital Gains Tax

Tax Deferred – 3 Ways to Avoid Capital Gains Tax

tax deferred picture of coins and banknotes

Taxes are necessary. Delaying or avoiding some tax will allow you to grow your wealth faster.

Tax deferral is important to understand so you can legally delay paying taxes as long as possible.

Tax deferred means putting off paying certain types of tax, typically capital gains. Sometimes you can avoid paying them altogether.

This post will explain 3 simple ways to delay or avoid paying capital gains tax.

Related Post: How to Get 158% More Income from Your Investments

First, what is Capital Gains Tax?

A capital gain is the profit you make when selling an investment or property.

Here are two examples of a capital gain:

Property Example

You buy a house for $250,000. You sell it 10 years later for $350,000.

Your capital gain is $100,000.

$350,000 (sale price) - $250,000 (purchase price) = $100,000 (capital gain)

The formula for calculating capital gain is: 

Sale price - purchase price = capital gain

You measure the increase in value of the property or investment when selling it. That increase is the capital gain.

Investment Example

You buy $20,000 of Apple stock (AAPL) in your investment account. Eight years later you sell your shares of Apple for $45,000. 

Your capital gain is $25,000.

$45,000 (sale price) - $20,000 (purchase price) = $25,000 (capital gain)

Once you know the capital gain amount, you need one more piece of information to figure out the capital gains tax: 

➡️ How long you owned the property or investment. ⏰​​

That length of time determines if the gain is a long-term or short-term capital gain.

Long-term capital gains are from property or an investment you owned for more than one year.

Short-term capital gains are from property or an investment you owned for one year or less.

There are different tax rates on long-term and short-term capital gains.

2019 Capital Gains Tax Rates

Type of Capital Gain

Tax Rate

Long-term (over 1 year)

0%, 15%, or 20%

Short-term  (1 year or less)

Ordinary income tax rate

The difference long term capital gains rates are based on your taxable income and filing status.

Ordinary income tax rate is the same rate you pay on earned income, like a salary or hourly paycheck. You would just add that short-term capital gain to the amount on your W-2. Then you calculate your income tax.

In almost all circumstances, long-term capital gains are preferred to short term capital gains.

Now that you understand what a capital gain is and how to calculate it, let's learn how to delay or avoid them. Even some short-term capital gains

3 Simple Ways to Delay or Avoid Paying Capital Gains Tax

If you have investments or property, use these 3 strategies to delay or avoid paying capital gains tax when you sell.

They are all legal and easy to do.


Use Tax Deferred Accounts

Avoid paying taxes on your capital gains, interest and dividends by using tax deferred accounts. 

The most popular are a Traditional IRA and a 401k (through your employer).

Money invested in one of these accounts grows tax deferred, meaning you don't have to report any gains or reinvested income within the accounts.

👇Here are two special tax deferred accounts you should have:

Roth IRA

A Roth IRA is a special type of tax deferred account.

You not only defer the taxes while the money is growing, but you never have to pay tax on the withdrawals. Like ever. 😀

HSA Account

An HSA account is one of the most important, but least used tax deferred accounts.

You get triple tax deferral:

First, you can deduct the contribution from your taxable income. Second, the money grows tax deferred like the others. Third, you pay no tax on the withdrawals if used for healthcare expenses.

Boom. 🚀


1031 Exchange Your Investment Property

When you 1031 exchange your investment property (also called a "like kind" exchange), you get to defer any capital gains tax.

Say you have a rental property you bought for $100,000. Now it's worth $250,000. You want to upgrade to a duplex.

You can 1031 the proceeds from the rental into the duplex and avoid paying tax on the $150,000 capital gain. 💰📈

Understand the nuances of 1031 exchanges.


Buy and Hold Indefinitely

The simplest way to defer paying capital gains tax is to buy an investment or property and hold it indefinitely.

If you don't sell, you won't owe any capital gains tax. No matter how much it has grown in value.

Say you buy an exchange traded fund for $20,000. You hold it and let it compound for many years. The value increases to $100,000.

As long as you still hold it, you owe nothing on the $80,000 gain. 💰📈😀

Important: You can't defer interest, dividends or other income you receive from the investment or property. For that you need to use tax deferred accounts (#1 above).

Summary and Next Steps

Use these 3 simple ways to delay or avoid paying capital gains tax.

  1. Tax deferred account
  2. 1031 exchange for investment property
  3. Buy and hold indefinitely

You'll build more wealth quicker by compounding your gains without giving up some to taxes.

Take advantage of legal and easy strategies to keep your money tax deferred.

- Tommy Sikes

Related Post: How to Get 158% More Income from Your Investments