When an asset, such as a home, car, investment, or piece of jewelry, is sold, a capital loss or gain is realized. A capital loss occurs when an asset is sold for less than its purchase price, while a  capital gain describes the sale of an asset for more than its purchase price. Capital gains are taxed at the individual’s marginal tax rate. Individuals whose marginal tax rate is 10% or 15% pay no tax on capital gains. There are many ways to reduce or even eliminate capital gains tax.

Make Use of the Primary Residence Exclusion

You are allowed to reduce the profit of the sale of your primary residence by $250,000 ($500,000 if you are married). You must meet three requirements to qualify for this exclusion, you must:

  1. have owned the primary residence for five years
  2. have lived in the primary residence for at least two years
  3. not have used a primary residence exclusion in the past two years before the current sale.

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Keep Records of Home Renovations

When preparing to claim after selling your house, you are allowed to add certain costs to the base cost of the house, such as agent fees, commissions paid, and transfer costs. You are also allowed to claim the cost of any improvements made to your primary residence, such as a boundary wall, an extension, or a swimming pool. By increasing the base cost of the house in this way, you are reducing the profit, hence a lower capital gain. It is vitally important that you keep supporting documents for all the expenses so your claims can be substantiated.

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Take Advantage of Strategic Losses

Towards the end of a year, you may sell off assets that are worth less than the purchase price. This transaction will incur a capital loss. You can use this capital loss to offset any capital gains made in the same year. Sales of this kind are completely legal, provided the same stock is not re-purchased with 30 days.

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Utilise the Versus Method

Over an investment period, you may have bought 1000 shares of the same stock at different intervals. If you decide to sell 200 shares, you are within your right to decide which 200 shares should be sold. With this in mind, you can allocate your current sale of 200 shares to the highest purchase price paid, thus reducing your capital gain. Ensure that you have the appropriate documentation to prove the purchase price and shares purchased.

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Section 1031 Exchange

Section 1031 is only available to businesses. When a business sells a property and uses the gains from the sale to purchase a new property, the transaction is treated as a “like kind” exchange. Tax is not levied on the sale, rather, the cost of the original property replaces the cost of the new property. This is a tax deferral mechanism, and the Capital Gains Tax will be levied if the business ever sells a property and does not purchase a new one with the gains.

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Set up a Charitable Trust

You are allowed to set up a charitable trust to transfer your assets to a charity after a pre-determined number of years or upon your death. This allows you to avoid paying capital gains tax while your assets appreciate in value and you enjoy the assets. It must be noted that the asset will be disposed to the charity upon your death, so your heirs may not stake a claim to this portion.

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Short- Term vs. Long-Term Capital Gains

Short-term capital gains are gains on assets you have held for less than a year. These gains are taxed at the same rate as ordinary income -- between 10 and 39.6%. Long-term capital gains are gains on assets that have been held for more than a year. The tax rate for long-term capital gains ranges between 0 and 20%. Where possible, sell your assets after a year of ownership to take advantage of the lower tax rate.

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Dispose of Assets When Income is Low

If you or your spouse know you will be losing or quitting your job, this will significantly reduce your income. Capital gains are taxed at your marginal rate. Therefore, it makes perfect send to sell assets (at a gain) in the years when your income is at its lowest so that you pay a lower capital gain tax.

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Reduce your taxable income

You can legally reduce your taxable income to bring down your marginal tax rate. This can be done by taking full advantage of the allowed deductions and credits before filing your tax return -- for instance, donations to charities and expensive medical procedures. You can also increase your contribution towards an IRA to the maximum allowable amount. These measures will ensure that any capital gain realized will be taxed at the lower marginal tax rate.

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Donate assets to Family

A sure-fire way to avoid Capital Gains Tax is to donate the asset to a family member. The current tax laws allow you to donate up to $14,000 per year ($28,000 if married and filing jointly) without paying a gift tax. If you sell the asset at a later stage, the capital gain is paid by the new owner of the asset at his marginal tax rate. This strategy does not work if you donate to children or students under the age of 24, as these dependants pay tax at their parent’s tax rates.

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