One reason why people invest is to generate extra money. When investors sell that asset for more than what they paid, they come away with a profit, known as capital gains. The problem is that the capital gains will likely trigger a taxable event.
But are you on the hook for taxes if you reinvest that capital gain? The answer is yes in many cases: you pay taxes on reinvested capital gains. The tax rate depends on how long you held the asset and whether the capital gains are considered short-term or long-term:
- If you owned the asset for less than one year before selling, this is considered short-term. The gain is taxed as ordinary income.
- If you owned the asset for more than one year before selling, this is considered long-term. The profit is taxed as a capital gain.
In some cases, it’s possible to defer taxes through capital gains reinvestment using the following methods.
1031 Exchange
If you want to sell a real estate asset to replace it with a better one, a 1031 exchange could help defer capital gains taxes. The IRS keeps a close eye on the like-kind exchange process to ensure you meet the stringent deadlines and don’t have access to funds generated by the sale of your relinquished property. A Qualified Intermediary is required to oversee the relinquished and replacement property transactions and funds used for the exchange.
You could keep using the process to defer capital gains until your death. At that time, your heirs would receive the property with a step-up in basis (including deferred gains). This can mean your heirs won’t have to pay capital gains taxes on the sale of that property.
But the 1031 exchange can be used only for real estate for trade or investment purposes.
Qualified Opportunity Funds
Reinvesting your capital gains into a Qualified Opportunity Zone (QOZ) could also help defer taxes. A Qualified Opportunity Fund (QOF) targets economically distressed communities and funnels investors’ capital gains to help spur revitalization. Taxes on invested capital gains are deferred until Dec. 26, 2026. Like the 1031 exchange, QOF investments mean you must follow specific deadlines and guidelines to ensure the tax deferral status of your capital gains.
Retirement Accounts
If you keep your assets in a tax-advantaged retirement account, you can typically reinvest capital gains within that account without fear of triggering a taxable event. As long as funds or new assets remain in that account, the profits usually aren’t taxed. Remember that any withdrawals from that account are taxed at the ordinary income tax rates.
Taxes are Inevitable
While most investment goals are to generate wealth, that wealth will likely be taxed when you sell assets. It is possible to reduce or defer those taxes, however. As such, working with a financial advisor or tax specialist is your best bet to develop a tax-advantaged strategy that allows you to keep more of your wealth.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Costs associated with a 1031 transaction may impact investor’s returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
Investors in QOFs will need to hold their investments for certain time periods to receive the full QOZ Program tax benefits. A failure to do so may result in the potential tax benefits to the investor being reduced or eliminated.
If a fund fails to meet any of the qualification requirements to be considered a QOF, the anticipated QOZ Program tax benefits may be reduced or eliminated. Furthermore, a fund may fail to qualify as a QOF for non-tax reasons beyond its control, such as financing issues, zoning issues, disputes with co-investors, etc.
Distributions to investors in a QOF may result in a taxable gain to such investors.
The tax treatment of distributions to holders of interests in a QOF are uncertain, including whether distributions impact the aforementioned QOZ Program tax benefits.
A QOF must make investments in Qualified Opportunity Zones, which carries the inherent risk associated with investing in economically depressed areas.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
FAQs
You do not pay taxes on the money you use to invest, but any profits or gains you make from investing are subject to taxes. You can typically reinvest the gains without paying taxes on them until you sell the stocks and realize the gains.
Do I pay taxes on capital gains that are reinvested? ›
A capital gains distribution is the investor's share of the proceeds of a fund's sale of stocks and other assets. The investor must pay capital gains taxes on distributions whether they're taken as cash or reinvested in the fund.
How can I reinvest my gains without paying taxes? ›
An easy and impactful way to reduce your capital gains taxes is to use tax-advantaged accounts. Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes at all on the assets in the account.
Is there a way to avoid capital gains tax on the selling of a house? ›
You will avoid capital gains tax if your profit on the sale is less than $250,000 (for single filers) or $500,000 (if you're married and filing jointly), provided it has been your primary residence for at least two of the past five years.
Can you reinvest profits to avoid tax? ›
Reinvested money in your business will be classed as a business expense or a capital investment. This could reduce your business Corporation Tax bill and allow you to make use of tax reliefs and allowances. If you are investing in certain things such as vehicles, equipment, hardware, plant and machinery etc.
What if capital gain is reinvested? ›
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.
How do I avoid capital gains tax on my investment account? ›
Investing in retirement accounts eliminates capital gains taxes on your portfolio. You can buy and sell stocks, bonds and other assets without triggering capital gains taxes. Withdrawals from Traditional IRA, 401(k) and similar accounts may lead to ordinary income taxes.
What is a simple trick for avoiding capital gains tax? ›
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
Do you have to pay capital gains after age 70? ›
Whether you're 65 or 95, seniors must pay capital gains tax where it's due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, which is known as the “tax basis.”
How to pay 0 capital gains tax? ›
Capital gains tax rates
A capital gains rate of 0% applies if your taxable income is less than or equal to: $44,625 for single and married filing separately; $89,250 for married filing jointly and qualifying surviving spouse; and.
Going by your list, the 6-year rule covers the first 6 years you rent your property out. After this when it's vacant for 6 months you can still treat it as your main residence because it's not being used to produce income. If you rent it out again straight after, then this period is subject to CGT.
Can I sell stock and reinvest without paying capital gains? ›
You and other investors who want to avoid paying tax on stocks that have appreciated, will “sell” (in actuality contribute) and reinvest, through a swap. This process involves swapping your appreciated shares for a diversified portfolio of stocks of equivalent value, effectively deferring capital gains tax.
What lowers capital gains tax? ›
Long-term investing offers a significant advantage in minimizing capital gains taxes due to the favorable tax treatment for investments for longer durations. When investors hold assets for more than a year before selling, they qualify for long-term capital gains tax rates, typically lower than short-term rates.
Do you still have to pay capital gains tax if you reinvest? ›
While you'll still be obligated to pay capital gains after reinvesting proceeds from a sale, you can defer them. Reinvesting in a similar real estate investment property defers your earnings as well as your tax liabilities.
Do I have to buy another house to avoid capital gains? ›
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
Do I have to pay capital gains tax immediately? ›
Do I Have to Pay Capital Gains Taxes Immediately? In most cases, you must pay the capital gains tax after you sell an asset. It may become fully due in the subsequent year tax return. In some cases, the IRS may require quarterly estimated tax payments.
Can you reinvest stocks without paying capital gains? ›
You and other investors who want to avoid paying tax on stocks that have appreciated, will “sell” (in actuality contribute) and reinvest, through a swap. This process involves swapping your appreciated shares for a diversified portfolio of stocks of equivalent value, effectively deferring capital gains tax.
Are undistributed capital gains taxable? ›
Some mutual funds and REITs keep their long-term gains and pay tax on them, rather than distributing them to shareholders. If you've invested in one of these, you'll receive an IRS Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains. Attach Copy B to your Form 1040.
Do you pay taxes on unrealized gains? ›
unrealized gains. Gains that are "on paper" only are called "unrealized gains." For example, if you bought a share for $10 and it's now worth $12, you have an unrealized gain of $2. You won't pay any taxes until you sell the share. Unrealized gains could be very important if you invest in funds, however.
Do you pay taxes on stock gains if you don't sell? ›
Do you pay taxes on stocks you don't sell? No. Even if the value of your stocks goes up, you won't pay taxes until you sell the stock. Once you sell a stock that's gone up in value and you make a profit, that's when you'll have to pay the capital gains tax.
