How to Avoid Paying Income Tax on a Large Capital Gain

The taxes you owe might diminish the satisfaction you feel from earning a large capital gain.
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Capital gains represent profits from the sale of investments, such as stocks. While the goal of most investors is to generate profits, the downside is that you usually have a price to pay in the form of additional taxes. If you have a large capital gain, you could be facing thousands of dollars in taxes. Certain accounting strategies can help lessen the sting, but in most cases, you can't simply avoid paying your taxes.

Defer Realizing Gain

The good news about having a large capital gain is that you can choose when you want to take it. For tax purposes, only "realized" gains matter. No matter how big of a profit you show in your account, the tax man is only interested once you sell your investment and book your profit. Even if you hold a stock for 50 years and show more than $1 million in profit in your account, you won't have to report that "unrealized" gain to the Internal Revenue Service. It only becomes "realized" when you sell it.

Lower Your Income

The capital gains tax rate varies based on your income. For 2013, the IRS uses three income brackets to determine the amount of tax you'll have to pay on your gain. If your total taxable income as a joint filer is between $72,501 and $450,000, you'll pay 15 percent on your long-term capital gain. A long-term capital gain is defined as one that you've held for longer than one year. However, if you can get your net taxable income to $72,500 or lower, you'll actually pay zero income tax on your long-term capital gain.

Lengthen Your Holding Period

You can't totally eliminate the taxes on your capital gain if you hold your investment for longer than one year, but you can still save a bundle. Gains held for one year or less are short-term gains, and they don't benefit from the reduced capital gains tax rate. Rather, you'll have to pay the same rate on your short-term gain as you do on all of your other income. If your gain is large enough, you could find yourself in the highest tax bracket, which topped out at 39.6 percent as of 2013. If you could hold your gain for longer than one year, you may be able to save at least 19.6 percent in taxes, because the top long-term capital gains rate peaks at 20 percent.

Offset Your Gains

One way to completely avoid taxes on your capital gains is to have an equal amount of capital losses. The IRS allows you to match up your gains and losses to determine a net profit or loss. If you have enough losses, you're allowed to offset an unlimited amount of gains. You don't even have to take the losses in the same year as your gain. The IRS permits you to carry forward any losses you might have taken in previous years. Some investors harvest losses every year by selling losers and using them to offset realized gains.

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