Capital gains tax loopholes are legitimate ways for taxpayers to save on taxes. Here’s a quick look at the best ways to reduce your capital gains taxes, a few popular available tax loopholes, and several tips on how to lower your tax liability.

What are Capital Gains?

In simplest terms, capital gains happen when you sell a capital asset for more than you paid. The IRS includes almost all assets you own as “capital assets.” These include both home and personal assets (vehicle, furniture, collectibles, artwork, your home) as well as your investments (typically stocks, bonds, real estate, etc.).

Few capital assets qualify as non-taxable for most individuals. That said, there are ways to reduce the impact of any capital gains, as we outline below.

How Much Are Capital Gains Taxes?

Americans usually pay no more than 15% tax on “net capital gains” if your taxable income is more than $40,400 and less than $445,850 for individuals or more than $80,800 and less than $501,600 for qualifying widowers or couples joint filing. However, your tax rates can rise to 20% by the amount you exceed these 2022 income thresholds.

There are a few exceptions where taxes may be higher on items such as gains on the sale of small business stock (25%), collectibles (art, jewelry, precious metals, coins at 28%), and some real estate sales (25%).

Are There US Capital Gains Tax Loopholes?

There are straightforward ways to reduce your potential tax on capital gains depending on how long you have owned the assets before settling them. Remember, you’ll pay no capital gains tax if your income is below $40,400, less than $80,800 with a spouse, or $54,100 if you’re head of your household.

Short-term vs. Long-term Capital Gains

If you own and sell an asset in less than one year since purchasing it, that’s considered a short-term gain or loss. Long-term capital gains may have a lower tax rate than short-term assets in most situations.

Non-taxable Capital Assets

Some capital assets are non-taxable, including business inventory, accounts receivable, real estate used in your business as rentals, and depreciable business property. In addition, some self-created intangibles do not incur capital gains taxes, such as copyrights, patents, inventions, designs, literary creations, music or artistic compositions. That’s all due to the 2017 Tax Cuts and Jobs Act.

Types of Legitimate Tax Loopholes

Tax loopholes are legitimate ways to reduce your tax liability, three of which are the most common:

1. Carried interest loophole: usually applies to hedge fund managers, VCs or partners in a private equity firm and allows compensation to be taxed at the lower long-term capital gains rate.
2. Backdoor Roth IRAs: individuals with earnings over $140,000 can not contribute to a Roth IRA but can convert a traditional IRA into a Roth IRA to circumvent this salary limit.
3. Foreign-derived intangible income (FDII): companies doing business outside the US may get tax breaks for moving assets overseas.

Capital Gains Tax-Saving Tips

While they’re not tax loopholes, there are additional ways to reduce your taxable income to get a lower capital gains tax rate. Take advantage of the following: the saver’s tax credit, earned income tax credit, American opportunity tax credit for students, lifetime learning credit, and child tax credit. And remember, if your capital losses exceed your capital gains, you may be able to reduce your taxable income.

These legal loopholes and tips may require expert advice from your tax advisor, who can provide valuable guidance when things get more complicated.

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