If you’ve ever bought and sold a rental property, a stock, or any investment, you were likely charged capital gains tax, whether you know it or not.
Capital gains tax gets a pretty bad rap, and rightfully so. This tax can take a huge cut of your profits from investments.
I’ll show you how it works, why it can be disadvantageous for investors, and how to avoid capital gains tax to a certain extent. That’s right, there are strategies you can follow that can greatly reduce the taxes you pay on your profits so you can keep more of your money.
When you invest the Rule #1 way, you can easily avoid capital gains tax. Here’s how.
What is Capital Gains Tax?
Capital gains tax is a federal tax that occurs when you profit from the sale of an investment (i.e. when you sell shares of a stock for more than you paid for it).
You get taxed on the amount you profit from the sale, or the capital gain.
Capital gain = selling price - purchase price
Stocks aren’t the only assets that are taxed under capital gains tax. Other capital assets include bonds, jewelry, vehicles, collectibles, and property, such as your home. Now, if you want to learn how to avoid capital gains tax on real estate, that’s a topic for another time. Here, we are going to focus specifically on stocks.
The capital gain falls into one of two categories that depend on how long you owned the asset or stock for— a short-term capital gain or a long-term capital gain. The distinction between these two is critical as the amount you will pay in taxes on each type varies greatly.
Short-Term Capital Gains
Short-term capital gains are gains on stocks that are held for one year or less. Short-term capital gains are taxed at your ordinary-income tax rate, which could be as high as 37% per 2024-2025 tax brackets, not including state income tax.
Profits from the sale of a stock that you held for, say, nine months and then sold, are taxed at this rate. We’ll get to it next, but this is much higher than long-term capital gains tax.
Long-Term Capital Gains
If you hold an investment for more than a year before selling, your profit is considered a long-term capital gain and is taxed at the capital gains tax rate, which is either 0%, 15%, or 20%. This is based on your taxable income and filing status (i.e. single, married, head of household, married filing separately).
For the 2025 tax year, long-term capital gains tax rates remain at 0%, 15%, and 20%, but the income thresholds have been adjusted for inflation.
These rates are pretty straightforward, but there are some additional rules. For instance, high-income earners are subject to an additional 3.8% NIIT on capital gains. This tax applies to single filers with modified adjusted gross income (MAGI) over $200,000 and married couples filing jointly with MAGI over $250,000.
For every level of income, the long-term capital gains tax rate is less than the short-term capital gains tax rate. This means if you hold your investments for longer than one year, you could pay far less in taxes on the profits gain.
Let’s put this into perspective. If you make around $90,000 a year and purchased a company in September of 2020 for $10,000 and sold it in August of 2024 for $15,000, you would pay at least $1,200 in capital gains taxes.
If, however, you held onto the company until now (longer than one year) and then sold it for the same price, you would pay about $750 in capital gains taxes.
That’s a difference of 37.5%!
This is why it’s so important to invest with a long-term mindset.
It’s right there in the numbers — our tax system is set up to benefit long-term investors!
The Rule #1 investing strategy is a long-term strategy that benefits investors in so many ways, like saving on taxes.
Effective Strategies to Minimize Capital Gains Tax
So, long-term capital gains are better than short-term capital gains, and as a Ruler, you should only have to deal with these anyways. However, taxes are taxes, so there’s a downside to long-term capital gains taxes too. But if you follow these tips, you can make the most of your tax situation.
Buy & Hold for the Long-Term
As Rule #1 investors, we strive to invest in wonderful companies that will continue to grow for five, ten, or even fifteen years. The goal of this strategy is to see our money grow and compound and grow some more until we have created incredible wealth that will support us and help us survive.
That means watching investments double and triple in value over a matter of years. Not only will following this strategy make you money, but it will save you money on taxes too.
If you call yourself a Ruler, you will want to buy and hold your investments anyway, so avoiding short-term capital gains is relatively easy.
Remember this. Don’t be influenced by peer pressure to sell early or to take part in day-trading. These tactics are like the shiny poison apple; they look enticing but will only hurt you in the end.
Another way to avoid short-term capital gains is to set your investments and forget about them. Set price triggers to notify you if they drop in price so you can buy more and set news alerts to be notified of any major company news. Otherwise, leave your investments alone so you won’t be tempted to sell them before you should.
Use Tax-Loss Harvesting to Offset Gains
Offset capital gains by realizing losses on other investments. This strategy allows you to deduct up to $3,000 ($1,500 if married filing separately) against ordinary income annually, with excess losses carried forward to future years.
Imagine you've invested in two different companies:
Stock A has appreciated, giving you a gain of $5,000
Stock B, however, has dropped in value, leaving you with a loss of $4,000
If you sell both stocks within the same tax year, you can offset the $5,000 gain from Stock A with the $4,000 loss from Stock B. Now, your taxable capital gain is reduced to just $1,000.
If your total losses exceeded your gains (for example, a $5,000 loss against a $2,000 gain), you could deduct up to $3,000 of the remaining loss against your ordinary income this year. Any additional loss would then carry forward to reduce gains or income in future tax years.
This strategy can significantly reduce your immediate tax bill and help optimize your long-term investment returns.
Donate Appreciated Stocks to Charitable Organizations
Donating appreciated stocks directly to a qualified charity can help you avoid capital gains tax on those assets and provide a charitable deduction.
Identify Appreciated Stocks
Choose stocks that have significantly increased in value since you purchased them and that you’ve owned for more than one year.
Select a Qualified Charity
Ensure the organization you're donating to is an IRS-approved 501(c)(3) charity to guarantee your donation is tax-deductible.
Contact Your Brokerage
Notify your broker that you’d like to transfer shares directly to a charitable organization. Most brokerage firms have established procedures and forms to simplify this process.
Transfer Shares Directly
Have your broker transfer the stocks directly to the charity. Never sell the shares yourself and donate the proceeds, as selling personally would trigger capital gains tax.
Receive a Tax Deduction
You’ll typically qualify for a tax deduction equal to the full fair-market value of the stock on the day of donation. Additionally, you completely avoid capital gains taxes on the appreciation.
Example:
If you purchased stock originally worth $2,000, which is now worth $5,000, donating it directly to charity allows you to:
Avoid capital gains taxes on the $3,000 of appreciation.
Claim a charitable deduction of $5,000 on your tax return.
This strategy benefits both your finances and a charitable cause, making it a win-win for strategic investors.
Gift Appreciated Stocks to Family Members
Gifting appreciated stocks to family members in lower tax brackets can reduce the overall capital gains tax burden, as the recipient may pay taxes at a lower rate upon selling the assets.
For 2025, you can gift up to $18,000 per recipient annually (or $36,000 if you and your spouse jointly gift) without triggering gift taxes.
Apply Rule #1 Value Investing Strategy
Now, the above only applies if you have actually done the work and researched the companies you are investing in to ensure they are indeed wonderful.
You can feel confident in buying and holding your investments for the long-term when you know the value of the company. This means checking off all of the 4Ms before you hit buy.
Anytime you consider selling your ownership in the company, revisit the 4Ms to see if the stock price is still below the value, or if it is overvalued.
There are some instances where it will make sense to sell (even if you have to pay short-term capital gains tax). For one, if the stock price jumps above what you think the company’s intrinsic value is, it’s time to sell.
Second, if the company’s story changed for the worse— such as they hired a terrible new CEO or they were bought by a company you know nothing about— then it may also be time to sell.
Finally, if you need the money from an extremely profitable investment for a better investment where you can get better returns, you may also want to sell.
The rule in these cases is that you could easily lose more than you’d save on capital gains tax by holding onto the company a little longer. Apart from these three instances though, you never want to let a wonderful company go.
Your investment could continue to grow (even if it’s already doubled!) and you don’t want to make the mistake of selling a wonderful company for the wrong reason, or just because you got a little greedy.
Exploit Tax-Deferred Retirement Plans
The only sure way to avoid capital gains tax on your investments is to utilize a tax-free or tax-deferred retirement account. These include IRAs, Roth IRAs, 401ks, and 403bs. With all of these accounts, you can buy and sell stocks without being charged capital gains tax — ever.
With a tax-deferred account, such as an IRA, 401k, or 403b, you can contribute pre-tax dollars, but the gains will be taxed as ordinary income when you withdraw the money. However, when you retire, you may be in a lower tax bracket than you are in now, and thus will pay less in taxes.
Additionally, you can deduct your contributions from your income, thereby reducing your taxable income, and perhaps even putting yourself into a lower tax bracket.
With a tax-free account, such as a Roth IRA, you contribute after-tax dollars but can withdraw the money tax-free during retirement.
Of course, the main reason you may not be able to avoid capital gains tax all of the time by doing this is that there are contribution limits on these accounts. But, it’s smart to contribute as much as you can and invest that money the Rule #1 way because when you make a profit, you won’t be charged capital gains tax.
The Bottom Line
If you’re a ruler, you’re already investing in a way that will help you avoid a big portion of capital gains tax. Stick to that long-term mindset and you’ll save more money on taxes and avoid falling into the traps of day trading or purchasing stocks with a short shelf life.
If you want to learn more about how to reduce your risk, enhance your profit, and benefit more from your investment decisions, grab my Cheat Sheet for Smarter Investing.
Now… go play.
Attend a Rule #1 Workshop
Learn how to conduct research, choose the right companies for you, and determine the best time to buy.
