Your main goal when you invest is to make money. But the IRS wants its cut of your profits, and usually, you have to pay taxes on any capital gains that you have when you sell an investment that has gone up in price. You can expect the 2015 capital gains tax rates to stay pretty much the same as they were in 2014, but many people still get confused about the ins and outs of paying taxes on capital gains more broadly. Let's look at a few basic tips you can use to pay as little as possible in capital gains taxes in 2015 and beyond.
1. Don't want to pay capital gains taxes? Don't sell
Perhaps the most important tax break that many people don't realize they get is that no matter how much a stock you own goes up in price, you don't owe capital gains taxes on your profits until you actually sell the stock. That means long-term investors get a huge tax break in the form of deferral of tax, even if they own a stock in a regular taxable account.
Investors in mutual funds have to deal with different rules, though, whereby funds can actually pay out capital gains distributions even if you don't sell your shares. The reason: when the fund sells the investments it owns, it has to pass through the resulting capital gains to you for you to include on your tax return. Using exchange-traded funds rather than traditional mutual funds can help cushion the blow here, as their different structure makes them less prone to generate capital gains.
2. Long-term traders sometimes pay nothing in capital gains taxes.
If you hold investments for longer than a year, then you qualify for long-term capital gains treatment, which involves lower rates. In fact, for those who are in the 10% or 15% tax brackets for ordinary income like wages or interest income, long-term capital gains qualify for a special 0% tax rate -- meaning you won't pay a penny on your profits. Even those who are in higher brackets will pay a maximum of 15% unless you're in the top bracket, in which case a 20% maximum applies. The 20% rate took effect in 2013; before that, 15% maximums applied all the way up the income scale. Keep in mind, though, that for taxpayers who earn more than $200,000 for singles or $250,000 for joint filers, an extra 3.8 percentage point net investment income surtax applies, boosting your total effective tax rate.
3. Short-term traders pay the highest capital gains taxes.
If you hold property for a year or less, then you don't get to take advantage of any of the favorable long-term capital gains tax rates you've heard about. Instead, you'll pay the same tax rate you do for other types of income, including wages, interest income, and retirement-account distributions. You could pay short-term capital gains taxes of as much as 39.6%, as well as having to add on the 3.8% from the net investment income surtax. The easiest way to avoid the high short-term capital gains tax: hold onto stocks for longer than a year so you can get the better long-term rate.
4. Another smart tax-cutting strategy: use losses to offset gains.
Toward the end of the year, many investors look for capital losses that they can use to offset any capital gains from earlier in the year. Because you only have to pay tax on any net capital gains, a loss on one investment can cancel out gains on another. So if you expect to have a big capital gains liability early in 2015, then you spend the rest of the year looking for losing stocks in your portfolio whose losses you can use to reduce or eliminate any net capital gains.
5. The ultimate tax dodge (warning: it comes at a high price)
One little-known way to avoid capital gains tax forever is to hold onto your assets until your death. Assets you own in a taxable account get a step-up in their tax basis when you die, and as a result, your heirs won't have any capital gains tax liability at all if they sell shortly after your death. Of course, that's not a strategy you can use for yourself, and so it represents a tension between your own financial interests and those of your broader family.
Tax planning can seem complex, and in some cases, it is. But dealing with capital gains doesn't have to be hard. Keep these simple tactics in mind, and you'll go a long way toward reducing your 2015 capital gains tax bill.
Dan Caplinger has no position in any stocks mentioned. Nor does The Motley Fool. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.