Strategies for Reducing Capital Gains Tax
Written by Steve Harrison, Enrolled Agent
Has 2026 been a life changing year? For many investors, the answer is yes. Due to realized capital gains, a large number of investors are looking at significant tax bills. Inevitably this leads some investors to look for tax advice on social media or from AI. This blog post is designed as a primer on tax planning around capital gains and, hopefully, will start you down the right path.
Questions You Need to Answer
The following is a checklist of questions to consider when you are calculating and planning for your capital gains tax.
Question 1: Are Your Gains Long or Short Term?
Long term capital gains are gains from any assets (including stock) that was held for at least 1 year and 1 day (or greater than 1 year). Anything else is short term, except certain derivatives known as Sec 1256 contracts (these are treated as 60/40). Long term capital gains have a much more favorable tax treatment with rates ranging from 0% to 20%. Short term capital gains are taxed as ordinary income, which can be as high as 37%.
Question 2: What State Do You Live In?
Not all states adhere to the favorable federal treatment of capital gains. Most treat it as ordinary income. Also state tax rates can vary wildly. Make sure that you calculate your state income tax when determining what you will owe on your stock sales.
Question 3: Do You Owe NIIT(ax)?
Depending on filing status, households with income above a range of $125,000 to $250,000 may have income subject to Net Investment Income Tax or NIIT. (See the footnote for more details)1 This tax applies to your capital gains regardless of your holding period. However, you can deduct certain investment expenses against NIIT to reduce the income subject to the tax. This deduction can easily be missed as many professionals confuse the deductibility rules for NIIT with the deductibility rules for Itemized Deductions.
Question 4: Do You Need To Make Estimated Payments?
If you had a banner year in 2025 and 2026 is shaping up the same way, you may need to make estimated payments, or you could face a penalty. The government generally expects you to pay enough tax throughout the year through withholding and estimated payments. If you fail to do so, you may be subject to an underpayment penalty.
Generally, you can avoid this penalty if you pay at least 90% of your current-year tax or 100% of your prior-year tax, whichever is less. For higher-income taxpayers, the prior-year safe harbor is generally 110% instead of 100%.
For many investors, 2025 was a great year. You may have gotten away without a penalty if your 2024 income was lower, but two bumper years back to back can set you up for a significant penalty if you are not paying attention.
Reducing Your Tax Bill
Often times the easiest way to reduce your tax bill is by making the simplest decisions. Things such as maximizing your 401(k) aren’t sexy…but they make a difference. Here is a checklist of simple strategies you can use to potentially reduce your tax bill.
Track Carryovers.
If you bounce from one accountant to another, you may lose carryovers from previous years. Capital losses first offset capital gains. If your losses exceed your gains, you can generally deduct up to $3,000 of net capital losses against ordinary income each year, with the rest carried forward to future years. Those carryovers can help offset a big bill later. Make sure you do not lose your capital loss carryovers due to poor tracking.
Use The Right Basis.
All gains and losses are based on your adjusted stock basis. This is especially important to understand if your gains comes from stock that was inherited or from employee stock grants. Often, the basis that’s reported by your brokerage is incorrect. It’s your responsibility to track your basis and failure to do so can lead to costly mistakes.
Max Your Tax Deferred Accounts
Too many clients contribute to their 401(k) only up to the company match and nothing beyond that. This is a mistake. You have a contribution limit that is based on your age, and in banner years, you should consider maxing it out.
Also consider whether you or your spouse is eligible for an HSA or a traditional IRA. However, you need to be careful with IRAs; income limits may prevent you from making deductible contributions. In that case, a backdoor Roth can be a good idea, but you have to consider the pro-rata rule. Work with a financial professional on this one.
Donate Appreciated Stock
If there was a Mount Rushmore of tax breaks, Qualified Small Business Stock, HSAs and Donating Appreciated Stocks would definitely be three of my four. Donating Appreciated Stock allows you to avoid the tax hit AND potentially get the full value of the donation as an itemized deduction. Of course, for this to work, you have to actually itemize your deductions.
Gift Stock
Another way to lower your tax bill is to gift stock to your loved ones. A couple of caveats: first, be careful with the Kiddie Tax rules. Second, remember that gifts over the annual exclusion may require a gift tax return.
Bunch Itemized Deductions
I probably should have bunched this with donating appreciated stock but bunching is a simple strategy which is often overlooked. The idea is to pull forward some of next year’s itemized deductions into this year. That way you boost your itemized deductions, and next year you can take the standard deduction.
This works especially well with things such as charitable donations which are easy to control. Keep in mind that deductions for paid state and local taxes may have a phase out as to deductibility depending on your income.
Harvest Losses
Sell your losers to offset your winners. Be careful with wash sale rules on this one. If you buy the stock back too soon, you’ll trigger a wash sale and the loss won’t be permissible.
What Not To Do
Here are some really bad ways people try to reduce their taxes.
Open a Trust
Generally speaking opening a trust is not a bad thing. However, if you don’t know what you are doing, you can make a bad situation worse by messing with trusts. If you’re trying to do estate planning, that’s fine, work with a qualified professional. If you think that Trusts are magical income tax havens, you may be in for a rude awakening come tax time.
Buy Insurance
I’m not sure which insurance agent created the social media myth that insurance is a tax hack. Life insurance is generally not deductible. It has it’s place, but not as an income tax strategy.
Open a Business for the Write Offs
Just like a trust, opening a business is not necessarily a bad thing. However, it’s a really bad idea to open a business just to write off expenses. This is not considered a business for tax purposes, but rather it would be viewed as a hobby. Hobby losses are not permissible and unusual business losses can trigger audits.
The risk of being audited increases exponentially if you live in states with aggressive tax departments like California or New York. These states and many others use Artificial Intelligence to detect tax anomalies. Under audit you have the burden of proof, which means you must prove that this business has a true profit motive. Failure to prove that can lead to significant penalties and interest.
Buy a House or Rental Property for “Tax Purposes”
Buying a house can bring some tax benefits, such as mortgage interest and property taxes as itemized deductions. However, buying a house or rental property for the tax benefits can create another problem: if your down payment is the money you needed to pay taxes, you may have the IRS coming after you to collect the bill.
Rentals can be a tax strategy if you are looking to do short-term rentals with a cost segregation strategy, but you need to make sure you meet the material participation guidelines. Long-term rentals generally will not save you much if those losses are passive, and an investor’s banner year may disallow the losses.
Summing it Up
We just gave away our playbook. However, knowing and doing are often two separate animals. Working with a professional who understands conceptually what can be done, and how to do it, is critical when navigating large tax bills.
Many individuals ask me when they should have a tax advisor. I typically recommend that individuals who will pay more than $50,000 in combined federal and state taxes consider working with someone on a year-round basis. Working with an advisor is not always a guarantee that you will save money year in and year out. However, the savings in a banner year can often be enough to justify the cost for five to ten years.
Footnotes
1. NIIT is based on MAGI. The threshold’s are not indexed for inflation. For married individuals who file separately, the threshold starts at 125,000. Married Filing Jointly and Qualified Widower start at 250,000. All other statuses start at 200,000.