Taking sales proceeds and buying new stock typically doesn't save you from taxes.
The primary goal of all investors is to make money on their investments. Once you're fortunate enough to earn a profit on an investment, however, you also have to do what you can to keep as much as possible out of the hands of the tax man. With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.
Special tax provisions don't apply to stock
The Internal Revenue Code is full of provisions that allow people to take proceeds from sales of property and reinvest it without having to recognize capital gain. The most popular is in the real-estate industry, where so-called "1031 like-kind exchanges" make it possible for owners to swap properties without any tax consequences. Similarly, in the life insurance industry, what are known as "1035 exchanges" allow policyholders to switch from one life insurance policy or annuity policy to another without having to pay capital gains tax on the paper profits from the policy being swapped out.
No such provisions apply to sales of stock in taxable accounts. Taxpayers have to recognize all of their capital gains. If they've owned the stock for a year or less, then they'll pay short-term capital gains tax at their ordinary income tax rate on the profit. If they've held the stock for longer than a year, then the lower long-term capital gains tax rates will apply.
How to avoid capital gains tax
The fact that there's no way out of paying tax on reinvested gains is one key reason why tax-favored retirement accounts are so popular. Within an IRA, 401(k), or other tax-favored retirement account, you can make sales of stock or other investments without any immediate tax consequences at all. You can then reinvest those proceeds in new stock. Only once you make withdrawals from your retirement account will tax issues come into play.
For your taxable account, though, your best defense against capital gains taxes is to be a long-term investor. You don't have to recognize capital gains on stock until you sell, so that gives those who invest in companies they're comfortable holding for years or even decades a leg up on short-term traders, who will end up paying a much higher tax burden.
Some argue that reinvesting gains from stock sales should be tax-free. Lacking major reform, though, investors should simply take steps to minimize the number of sales that force them to recognize such gains. Click here to compare brokers and choose the one that offers the most benefits for your investing style.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at[emailprotected]. Thanks -- and Fool on!
FAQs
Yes, since you are actually selling one fund and purchasing a new fund. You need to report the sale of the shares you sold on Form 8949, Sales and Dispositions of Capital Assets. Information you report on this form gets posted to Form 1040 Schedule D. You are liable for Capital Gains Tax on any profit from the sale.
What happens if I reinvest capital gains? ›
The taxpayers can minimize or avoid paying tax by reinvesting capital gains from residential house property under the Income Tax Act, 1961. The taxpayer can either reinvest the capital gains in bonds or in a residential property. The taxpayer needs to fulfil a few conditions in both of the options to gain tax benefits.
Is it a good idea to reinvest capital gains? ›
Capital gains generated by funds held in a taxable account will result in taxable capital gains, even if you reinvest your capital gains back into the fund. Thus, it may be smart not to reinvest the capital gains in a taxable account so that you have the cash to pay the taxes due.
Do I pay capital gains and income tax on stocks? ›
If you sell stocks for a profit, you'll likely have to pay capital gains taxes. Generally, any profit you make on the sale of an asset is taxable at either 0%, 15% or 20% if you held the shares for more than a year, or at your ordinary tax rate if you held the shares for a year or less.
How to reinvest capital gains to avoid taxes? ›
Homeowners have options to reduce the taxes paid by using IRS Code Section 1031 to recognize a "like-kind" exchange when selling an investment property. In this manner, capital gains are able to be deferred by buying a similar investment property.
How to reinvest profits to avoid tax? ›
- Invest in Municipal Bonds.
- Take Long-Term Capital Gains.
- Start a Business.
- Max Out Retirement Accounts.
- Use a Health Savings Account.
- Claim Tax Credits.
How to Minimize or Avoid Capital Gains Tax
- Invest for the Long Term. You will pay the lowest capital gains tax rate if you find great companies and hold their stock long-term. ...
- Take Advantage of Tax-Deferred Retirement Plans. ...
- Use Capital Losses to Offset Gains. ...
- Watch Your Holding Periods. ...
- Pick Your Cost Basis.
Reinvested dividends may be treated in different ways, however. Qualified dividends get taxed as capital gains, while non-qualified dividends get taxed as ordinary income. You can avoid paying taxes on reinvested dividends in the year you earn them by holding dividend stocks in a tax-deferred retirement plan.
Do you pay tax on reinvested shares? ›
Shareholders who reinvest their dividends to buy more shares and grow their wealth still need to pay tax on these dividends as if they were paid in cash.
What is the capital gains tax for people over 65? ›
The capital gains tax over 65 is a tax that applies to taxable capital gains realized by individuals over the age of 65. The tax rate starts at 0% for long-term capital gains on assets held for more than one year and 15% for short-term capital gains on assets held for less than one year.
Dividends are taxable regardless of whether you take them in cash or reinvest them in the mutual fund that pays them out. You incur the tax liability in the year in which the dividends are reinvested.
Do I have to pay capital gains tax immediately? ›
It is generally paid when your taxes are filed for the given tax year, not immediately upon selling an asset. Working with a financial advisor can help optimize your investment portfolio to minimize capital gains tax.
At what age do you not pay capital gains? ›
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
Can I sell stock and reinvest without paying capital gains? ›
With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.
How can I avoid capital gains tax on stocks? ›
How to Minimize or Avoid Capital Gains Tax
- Invest for the Long Term. You will pay the lowest capital gains tax rate if you find great companies and hold their stock long-term. ...
- Take Advantage of Tax-Deferred Retirement Plans. ...
- Use Capital Losses to Offset Gains. ...
- Watch Your Holding Periods. ...
- Pick Your Cost Basis.
The tax doesn't apply to unsold investments or unrealized capital gains. Stock shares will not incur taxes until they are sold, no matter how long the shares are held or how much they increase in value.
Do I have to pay tax on stocks if I sell and reinvest Robinhood? ›
If you sell any stock using Robinhood, you must report this and pay taxes on the gains. Sometimes Robinhood gives away free stocks for referring a friend or creating an account. If the value of the stock exceeds $600, you'll need to report this to the IRS.
Can you avoid capital gains tax if you reinvest in an IRA? ›
Transactions that are not taxable in an IRA account include purchases, exchanges between mutual funds, buying and selling stocks, dividend reinvestments, and capital gain distributions. Mutual fund exchanges are not taxable as long as the money is being exchanged into an account registered as an IRA.
