Your goal as an investor should be to make money, so the last thing you want is the IRS coming in and grabbing a large piece of the cash you've managed to accumulate. Here are a few tricks experienced investors commonly use to avoid losing too much of their profits to taxes.
1. Hold stocks at least a year and a day
Buying stocks and holding them for a long time is a great strategy for growing wealth. But in some cases, you may feel compelled to sell a stock sooner.
If that's the case, do yourself a favor and aim to hold that stock for at least a year and a day. If you do, you'll bump yourself into a more favorable tax category if you make money by selling that stock at a profit.
Stocks held for a year or less are subject to short-term capital gains taxes, which are treated the same way as ordinary income. But stocks held for at least a year and a day move into the long-term capital gains category, which is taxed more favorably.
Imagine you earn $100,000 a year and sell a stock that's subject to short-term capital gains. Based on your income, you'd face a 24% tax rate. But if you were to wait until you'd be bumped into the long-term gains category, your tax rate on those gains would be just 15%.
2. Load up on qualified dividends
Just as long-term capital gains enjoy more favorable tax treatment, so, too, do qualified dividends. If you don't have dividend stocks in your portfolio, it pays to buy some. Not only can those dividend payments serve as a nice income stream, but you can set them up to be reinvested to grow even more wealth.
3. Use losses to offset gains
Nobody likes losing money in the stock market. But if you have a stock in your portfolio that's been underperforming and heading for a crash, it pays to unload it before its value sinks further. The good news, however, is that capital losses can be used to offset gains, thereby lowering your tax burden when you make money on stocks.
Say you take in $3,000 in capital gains but sell a stock at a $2,000 loss. That $2,000 can be applied against your gains so that you're only liable for taxes on your remaining $1,000 profit.
Not only can losses be used to cancel out gains, but they can also offset up to $3,000 of ordinary income per year. If you have stocks in your portfolio that aren't apt to recover lost value, unloading them strategically could work to your benefit.
There's a reason why wealthy investors get away with paying such low tax rates — they know how to work the tax code to their advantage. If you're going to invest, it pays to read up on the ways you can minimize your tax burden. Doing so could be your ticket to not only growing wealth, but keeping more of your money to enjoy.
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