The explosive move higher for stocks in the past several years has been great for stock investors, who've seen their portfolios largely recover from the 2008 bear market. But the IRS wants its share of your hard-earned investing profits, which means more taxpayers will have to pay tax on capital gains in 2014.
However, by following a few simple strategies, you can make sure that you pay as little tax on your capital gains in 2014 as you absolutely have to. Let's look at three of those strategies and find out how you can pay less to Uncle Sam in the years to come.
1. In taxable accounts, hold on to your investments for more than a year
The easiest way to reduce your tax on capital gains is to hold on to your investments for more than a year. That qualifies you for long-term capital gain treatment, which includes favorable rates that are lower than what you'll pay for capital gains on investments you hold for a year or less. Short-term capital gains tax rates are the same as your ordinary income tax rate, ranging up to 39.6%. But for long-term capital gains on most qualifying investments, the maximum tax is 20% for those in the highest tax bracket, 15% for those in the four tax brackets between 25% and 35%, and 0% for those in the 10% and 15% brackets.
Not all assets qualify for these particular preferential rates. Gold and silver bullion, as well as exchange-traded funds SPDR Gold (NYSEMKT:GLD), iShares Silver (NYSEMKT:SLV), and iShares Gold (NYSEMKT:IAU), are treated as collectibles, for which ordinary income tax rates apply subject to a higher maximum of 28%. Nevertheless, structuring your investments to hold them for longer than a year is the most obvious way to reduce your tax bill on capital gains in 2014 and beyond.
2. For quick trades, use tax-deferred accounts
Capital gains taxes make it expensive to be a short-term trader in a taxable account, but that doesn't mean you have to give up on all your opportunistic trading options. The key to avoiding capital gains with short-term trades is to use IRAs or other tax-deferred vehicles to hold those stocks.
The reason is simple: Even when you sell a winning stock in an IRA, you don't have to pay capital gains tax at that time. What happens instead is that the proceeds from the sale stay in the IRA and are available for reinvestment, and you'll only get taxed when you start making withdrawals from your retirement account. So if you're looking to take advantage of a short-term opportunity, such as a spinoff, special dividend, or buyout offer, buying it in an IRA will avoid a painful tax on eventual gains.
3. Look for capital losses to offset your gains
As in any other year, capital gains in 2014 will be netted against any capital losses you might have for the year. As a result, if you foresee selling some of your winning stocks next year, you should consider selling some of your losing stocks as well to offset those gains.
Tax considerations should only be part of your decision to sell a stock, though. If you sell a stock you like just to reap the loss, you won't be able to claim that loss if you buy the stock back within 30 days. That can lead to missing out on a rebound in that stock, forcing you to repurchase shares at a higher price after the 30-day period ends. Tactics like buying SPDR S&P 500 (NYSEMKT:SPY) or other index ETFs to substitute for an individual stock can reduce that risk, but nothing can eliminate it entirely. On the other hand, if you want to get rid of a losing stock for good, it only makes sense to use the tax loss to your best advantage.
It's easy to be tax-smart about your capital gains in 2014. By following these three simple strategies, you can make sure you pay as little tax on your 2014 capital gains as possible.
Fool contributor Dan Caplinger has no position in any stocks mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.