Selling Investments at a Gain? Do These Things to Avoid a Major Tax Hit

When you sell investments at a profit in an IRA, it doesn't impact that year's tax bill. That's because IRAs let you enjoy tax-deferred gains on your investments. (And with a Roth IRA, your gains are actually tax-free.) But when you sell investments at a profit in a taxable brokerage account, capital gains taxes come into play immediately.

This doesn't mean you'll have to pay the IRS the day you sell stocks at a profit. But if you sell a stock in July and earn $500 in the process, that $500 gain is taxable in 2023, and it's something your tax return will have to account for.

That's why if you're looking at selling investments at a gain, it's a good idea to do what you can to avoid a major tax crunch. Here are two moves you can make to soften the blow.

1. Hold investments for at least a year and a day

Capital gains taxes are broken down into two categories -- short term and long term. Short-term gains apply when you sell an investment at a profit after holding it for a year or less. Long-term gains come into play when you've held an investment for at least a year plus one day prior to selling it.

Why does this matter? It's simple -- you'll face a much larger tax hit for short-term capital gains than long-term gains. So it's important to be mindful of your timing when selling a stock at a profit.

Let's say you've held a given stock for 11.5 months and you're looking to sell it for a $1,000 gain. If you're single and earning $50,000 a year, that means you'll be looking at a tax rate of 22% on your profit. So all told, the IRS will get $220 from that sale. Again, this doesn't mean you have to pay the IRS $220 the day you make that sale, but it'll add to your tax burden for the year.

On the other hand, let's say you hold that stock a little more than two additional weeks and you end up bumping yourself into the long-term capital gains category. In that case, your tax rate on your profit is only 15%, so you're only talking about owing the IRS $150.

2. Sell stocks at a loss to offset gains

There may be stocks in your portfolio that have been steadily losing money since you bought them. If you don't think those stocks will eventually recover, then it could pay to sell them at a loss if you know you have capital gains on your hands. Any loss in your portfolio could help you offset gains.

So as an example, if you sell one stock at a gain and make $1,000 in the process, and you sell another stock at an $800 loss, you're only up $200. And so the IRS can only tax you on $200.

It's a good thing to make money on your investments. But it's also a good thing to hand the IRS as little money as possible. So it pays to make these moves if there's a winning stock you're sitting on that you know will result in a nice profit.