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Unless you enjoy spending time in federal prison, there's no good way to avoid paying your taxes. But luckily for you, the amount that you'll owe is not set in stone. A few smart moves can help you can fork over less Uncle Sam, and keep more money in your own pocket.
Tax savings start at home
The home sales tax exclusion is just one excellent example. Imagine buying a home for $200,000, then selling it for $400,000. Think you'll owe taxes on that $200,000 gain? Believe it or not, you may be able to reap that entire gain tax-free, provided you meet a few rules. (For instance, you must have had the home as your primary residence for two of the past five years.) The law permits individuals to exclude as much as $250,000 in gains from taxation -- and up to $500,000 for couples.
For longtime homeowners, this can be quite a big deal. Without the exclusion, normal capital gains tax rates of 15% if you've owned your home longer than a year would apply. The exclusion could save you as much as $75,000 in taxes.
Unfortunately, for those who bought nearer the top of the market, losses on the sale of your home generally aren't deductible.
Go long, and be timely
The difference between long-term and short-term capital gains tax rates can be huge. If you're about to sell a stock you've held for 11 months and realize a $10,000 gain, you're looking at a possible short-term tax hit of $2,500 to $3,000 or more. If you have enough faith in the stock to hang on for one more month, you can lower the tax bill to $1,500.
Aside from long-term vs. short-term rates, give some more thought to the timing of your stock sales. Jot down on a piece of paper what you expect your income to be this year and next, and what you expect your tax rates to be. Then list the stocks you want to sell, and how much of a gain or loss you expect to realize from each. If you expect tax rates to be higher next year, you may want to sell some holdings with gains this year rather than next -- and vice versa.
You can also use your losses strategically. If you have $5,000 in capital gains this year, and you're sitting on a stock with a $4,000 loss, you may be able to offset much of that taxable gain with the loss. Even if you still have faith in the stock, this can be a smart move. Sell, take the loss for tax purposes, wait 31 days to avoid "wash sale" rules, and then buy it back again. See? Even stocks that have let you down can still help save you money.
Shrink your income, and smile
You can deny Uncle Sam more money by making the most of tax-advantaged retirement accounts available to you. In 2010, for example, most folks can contribute as much as $16,500 to a 401(k) plan at work (or $22,000 for those 50 and older), and up to $5,000 to an IRA ($6,000 for those 50 or older). With both 401(k)s and traditional IRAs, making those contributions will lower your taxable income. Earn $60,000, contribute $10,000 to those accounts, and presto -- your taxable income is now just $50,000. Yes, you'll have less to live on today, but you'll pay less in taxes (and will have more in retirement). If the $10,000 you contribute would have been taxed at 25%, you'll be saving $2,500!
Tax benefits from money contributed to a Roth IRA can be even more exciting. Roth contributions are not deducted from your income, so there's no immediate savings. But if the rules stay the same, you'll be able to withdraw your money in retirement tax-free! You may be able to stiff Uncle Sam in a big way. If you invest $50,000 over the years in some stocks and funds that do well, and you retire with $160,000 in your Roth account, you'll pay nothing on that $110,000 gain.
The big picture
These ideas can all serve you well, but be sure to put the tax breaks in perspective. Sometimes it's smarter to lose the break if selling (or buying) something now is your best move. Similarly, if you're deep in high-interest credit-card debt, you may be best off paying that down as aggressively as possible, before investing for retirement.
Be smart with your financial moves. Employ a little tax-minimizing strategy and you can save thousands of dollars, if not tens of thousands.
Get more saving and investing guidance:
- How to Handle the Coming Tax Hikes
- Planning Your Taxes in a Crazy World
- 5 Stocks for Retirees to Get Rich On
True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.