How to Avoid Capital Gains Tax | Stewardship Concepts Financial Advisors

My (Amy) birthday is on Monday, so my husband and I (pictured above at Cedars 5 years ago) are celebrating this weekend with dinner at my favorite restaurant, Cedars, in Coeur d’Alene. If you haven’t been, I highly recommend it—it’s a floating restaurant on the lake. I’m looking forward to the date night and celebrating the past year! Today, I’m sharing how a financial advisor strategizes to minimize capital gains tax.

Capital Gains Tax & Income

When planning your tax strategy, it’s crucial to understand how capital gains tax interacts with your ordinary income tax bracket. Many investors assume that capital gains are taxed separately or in isolation, but in reality, your ordinary income determines the tax rate applied to your capital gains. Knowing how much income our clients will have is important when working with clients because we manage the capital gains from their taxable accounts as financial advisors. Their income determines how we rebalance or shave off some legacy stock positions.

Income Affects Capital Gains Tax

The tax system in the U.S. follows a progressive structure, meaning different portions of your income are taxed at different rates. When calculating your capital gains tax liability, the IRS first accounts for your ordinary income—such as wages, self-employment, rental income, retirement income, and interest. Once your total ordinary income is determined, capital gains are stacked on top, and the applicable tax rate is based on your total taxable income.

Long-term capital gains (for assets held longer than a year) benefit from preferential tax rates of 0%, 15%, or 20%, depending on your income level. Short-term capital gains (for assets held for one year or less) are taxed at the same rates as ordinary income.

Case Study – John & Martha Smith

Scenario 1: Capital Gains

John and Martha Smith work part-time in their second career and have $100,000 in joint W2 income for 2024, with most of their retirement money in John’s IRA.

They just recently became clients, but before they came on board, they sold a stock position this year and have had a long-term capital gain of $30,000.

Tax Outcome:

After accounting for their income and the standard deduction (using 2024 tax rates and tables), their taxable ordinary income is $70,800, placing them in the marginal 12% tax bracket.

Given the 2024 capital gains tax brackets, the first $23,500 total capital gain is taxed at 0%.

The remaining $6,500 of the capital gain is taxed at 15%, resulting in a $975 capital gains tax that John and Martha will pay when they file their tax return.

Scenario 2: Roth Conversion

John and Martha also desire to have money grow tax-free in a Roth account. Let’s consider a hypothetical scenario in which they converted money into a Roth IRA and how it affected their taxes.

John and Martha do a $25,000 Roth conversion in addition to their income in Scenario 1. This adds $25,000 to their ordinary income.

Tax Outcome:

After accounting for their income, the standard deduction (using 2024 tax rates and tables), and the Roth conversion, the couple's taxable ordinary income is now $95,800.

Given the 2024 capital gains tax brackets, none of the capital gains will be taxed at 0% since their ordinary income bumped them into the higher capital gains bracket.

All of their capital gains will be taxed at 15%, resulting in a $4,500 capital gains tax paid when they file.

As advisors, we didn’t recommend a Roth conversion for John and Martha for 2024 because of the capital gains rate bump, but we plan to do so in 2025. Their tax rate isn’t the only reason for our recommendation not to do a conversion. Other considerations are current and future income, tax-deferred account balances, charitable intent, heirs' tax situation, estate size, and cash flow. For more information, check out “Should I do a Roth conversion in 2025.”

Takeaways

Ordinary income is taxed first at standard progressive tax rates.

Capital gains are stacked on top of ordinary income and taxed at capital gains rates based on total taxable income.

Taking additional ordinary income, like a Roth Conversion, can push more of your capital gains into a higher tax bracket, increasing overall tax liability.

Creating a plan can help optimize your tax liability—for example, by spacing out capital gains over multiple years to stay within the 0% or 15% brackets.

Understanding how capital gains and ordinary income interact lets you make more informed investment and tax planning decisions. Suppose you’re considering selling an asset with substantial gains or taking additional withdrawals from a retirement account. In that case, consult your financial advisor or tax professional to help create a tax plan to save you thousands.

Schedule a no-cost, no-commitment discovery call with Stewardship Concepts' financial advisor today.