The 1031 exchange is a piece of tax code that allows real estate investors to sell their investment properties and defer the payment of capital gains taxes on that sale.
If you invest in stocks, then you may be wondering if the government offers a similar tax benefit to you.
Is There A 1031 Exchange For Stocks?
The 1031 exchange is a tool used for deferring capital gains taxes ONLY for real estate. The exchange can only be utilized to defer taxes on the sale of an investment property, and the money gained in the sale must be used to purchase another investment property.
The gains cannot be used to purchase stocks or anything other than an investment property. And you can’t defer taxes on the sale of a stock by purchasing an investment property with that money.
How Can I Avoid Taxes For Stocks?
That being said, there are methods to minimizing or eliminating the taxes paid on stocks. But how?
Forbes has a good article on deferring taxes on stocks, and I’ll reiterate some of their ideas below.
1. Watch your tax bracket
Just like income taxes, capital gains tax rates are dependent on your taxable income. For those with a sufficiently low taxable income, the capital gains tax rate is 0%. Here are the recent numbers.
- in 2019, $39,375 (single filers) and $78,750 (joint filers)
- in 2020, $40,000 (single filers) and $80,000 (joint filers)
This knowledge is going to come in handy later on, because we can now leverage every known way to lower our taxable income. If we have a high taxable income, we can use lots of techniques to lower that amount.
- Contribute to a non-Roth retirement account (contributions can be deducted from your taxable income)
- Open a Health Savings Account (contributions can again be deducted from taxable income)
- Claim business deductions from a side hustle
- Claim a Home Office Deduction
- Write Off Business Travel Expenses
- Deduct Half Your Self-Employment Taxes
- Get a Credit for Higher Education
- See if You Qualify for an Earned Income Tax Credit
- Itemize State Sales Tax
- Deduct Private Mortgage Insurance Premiums
- Make Charitable Donations
- Adjust Your Basis for Capital Gains Tax
- Avoid Capital Gains Tax by Donating Stock
- Claim Deductions for Military Members
- Don’t Forget State and Local Tax Breaks
This is far from a comprehensive list of ways to lower your taxable income, but I pasted the list here to show that you can save money simply by being informed. And don’t shy away from hiring a CPA to do your taxes for you, especially as your tax bracket gets higher over time.
2. Use tax free accounts like the 401k and IRA
We just saw that contributing money to a traditional 401k or IRA can allow you to take deductions to your taxable income. There is another huge benefit of these accounts that is no secret.
Your gains on the stock held inside these accounts grows tax free, meaning all capital gains realized on the stocks held in your retirement accounts will not be taxed.
My personal beef with retirement accounts
This is great, but if you read this blog often then you know I have some problems with retirement accounts. I think they are a great tool for anyone who intends to take the traditional path to retirement (work forever and eventually retire).
But I don’t intend to work until I’m 60 or older and I hope you have the same expectation for yourself. If you want to retire at 35 or 40, then the money you put in your retirement accounts can basically be stuck in there for 20 years.
Sure you can take it out, but when you take all the fees into account then you’re probably making out worse than if you’d avoided the accounts altogether. There are some ways to avoid the fees, but it takes a long time and you only get access to small amounts of your money each year.
3. Don’t sell
I’m historically an all out real estate cash flow investor, but I am slowly beginning to think about stocks as part of my investing strategy.
I don’t like to sell my cash flowing assets, because they are assets. They are making me richer over time, so why would I sell something if it’s making me richer? Really the only good reason to do that is to buy another asset that will perform even better.
So as stocks become part of my cash flow strategy, I intend to leverage the dividends rather than intending to sell after the value increases.
Qualified dividends are also taxed at the capital gains rate, but the difference is that you’re typically realizing less income as a result of dividends than you would be from selling.
Pass the stocks on when you die
As the law currently stands, if a loved one inherits your stocks after you die, they can sell those stocks and pay no capital gains tax on that sale.
If they hold on to the stocks and choose to sell sometime later, then they only pay capital gains based on the value of the stocks when they inherited them. This still cuts out all the gains realized during your life.
4. Claim losses
Capital gains are taxed on net gains. That means if you realize capital losses when you sell stocks, you can lower your net gains.
There are some extra rules around claiming losses, like limiting the amount of your losses that can be deducted. And in the end, you would never intentionally invest in something that is going to lose value, because that loss is only a deduction.
A deduction doesn’t have a one to one correlation with money saved on taxes. In most cases you’re only making back 20-30% of the amount you deducted.
But if you do happen to have realized losses in the tax year, don’t forget to claim them.
While stock investors don’t get a tax benefit as nice and shiny as the 1031 exchange, they do have plenty of options for minimizing or eliminating their tax burden.
As always, education is the key to making your wealth and keeping it out of the hands of the tax man.