Top Strategies to Defer Capital Gains Tax and Reduce Taxes

When selling investments like stocks, mutual funds, or real estate, investors often have to pay capital gains tax. The Internal Revenue Service (IRS) considers any profit from the sale of an asset as taxable income, which must be reported on a federal income tax return. 

However, the United States tax code provides ways to defer capital gains tax, allowing investors to reinvest their sale proceeds into new investments while postponing or reducing their overall tax liability.

In this article, we’ll highlight some of the most effective deferral strategies for long-term wealth preservation and smarter financial planning.

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How Capital Gains Taxes Work

Capital gains taxes are owed when an individual sells an asset for more than they originally paid. The difference between the sale price and the cost basis, which includes the original purchase price and any improvements or fees, is considered taxable income.

This amount must be reported on a federal income tax return and is subject to taxation based on how long the asset was held before the sale.

Short-Term vs. Long-Term Capital Gains

Short-term capital gains

Short-term capital gains apply to assets owned for one year or less before being sold. These gains are taxed as ordinary income, meaning they follow the same tax rates as wages or business earnings. Depending on a taxpayer’s total gross income and tax bracket, short-term capital gains can be taxed as high as 37%.

Long-term capital gains

Long-term capital gains apply to assets held for more than a year before being sold. These gains receive more favorable tax treatment, with rates of 0,15, or 20%, depending on the investor’s income level and filing status.

Because long-term capital gains are taxed at lower rates than short-term gains, many investors prefer to hold onto their assets for more than a year to reduce their capital gains tax liability.

Strategies to Defer Capital Gains Taxes

#1. 1031 Exchange: The Like-Kind Exchange Strategy

A 1031 exchange, also known as a like-kind exchange, is one of the most widely used tax deferral strategies for real estate investors. This approach allows an investor to sell an investment property and reinvest the proceeds into a replacement property of equal or greater value without immediately recognizing the capital gain.

Instead of paying capital gains tax at the time of sale, the tax liability is deferred until the investor sells the new property without reinvesting in another like-kind asset.

To qualify for a 1031 exchange, the investor must identify a replacement property within 45 days of selling the original one and complete the purchase within 180 days.

Requirement	Details
Identify replacement property	Within 45 days of selling the original property
Complete purchase of replacement property	Within 180 days of selling the original property
Property use requirement	Both the relinquished and replacement properties must be used for business or investment purposes
Personal property eligibility	Primary residences and personal property do not qualify for a 1031 exchange

By leveraging this strategy, real estate investors can continue growing their portfolio, increase cash flow, and delay tax payments until a later date.

Proper planning and working with a tax advisor can ensure compliance with IRS regulations and help maximize the benefits of this tax deferral strategy.

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#2. Installment Sale

An installment sale allows a seller to receive payments over time instead of collecting the full amount upfront. This approach can help reduce the overall tax burden in a single taxable year by spreading out the recognition of capital gains.

Instead of paying taxes on the entire gain all at once, the seller only reports and pays taxes on the portion received each year.

This strategy is particularly useful for investors who want to stay in a lower tax bracket. By spreading taxable income over multiple years, they can avoid pushing their income into a higher tax rate.

For real estate investors and business owners, installment sales provide an opportunity to generate ongoing cash flow while deferring capital gains tax. Since only a fraction of the gain is taxed annually, this method can help reduce the overall tax rate applied to the transaction.

#3. Qualified Opportunity Funds: Investing in Opportunity Zones

The Tax Cuts and Jobs Act created qualified opportunity zones to encourage investment in underdeveloped areas. This strategy allows investors to reinvest capital gains into a qualified opportunity fund and defer capital gains tax until 2026.

If the investment is held for at least five years, a portion of the deferred gain may be reduced. If it is held for ten years or more, any appreciation on the new investment can become completely tax-free.

This approach offers investors a way to defer taxes while also supporting economic development in designated opportunity zones. 

#4. Deferred Sales Trusts: An Alternative to 1031 Exchanges

A deferred sales trust (DST) is another method for deferring capital gains tax. Instead of receiving the full sale proceeds, the seller transfers the funds into a legally structured trust, which then makes periodic payments to the seller over time.

Since the gain is not recognized immediately, the tax is deferred until the seller receives the payments.

This strategy can be applied to a variety of assets, including real estate, businesses, and other capital assets.

Unlike a 1031 exchange, which requires reinvestment in like-kind property, a deferred sales trust allows the seller to invest in different types of assets while still enjoying tax deferral benefits.

#5. Delaware Statutory Trusts: Passive 1031 Exchange Investments

For investors who want to continue deferring capital gains taxes through a 1031 exchange but prefer a hands-off approach, a Delaware statutory trust (DST) can be an excellent option.

Instead of purchasing a single replacement property, investors can use their 1031 exchange proceeds to buy fractional ownership in a professionally managed real estate portfolio.

A DST provides passive real estate investment opportunities while still meeting IRS requirements for a 1031 exchange. This approach allows investors to defer taxes while maintaining consistent income from real estate without the burden of property management.

#6. Charitable Remainder Trusts: Combining Philanthropy with Tax Planning

A charitable remainder trust (CRT) provides another opportunity for deferring or eliminating capital gains taxes while supporting charitable organizations.

When an individual donates appreciated assets to a CRT, the trust can sell them without triggering an immediate tax liability. The donor receives an income stream from the trust for a set period, after which the remaining assets go to the designated charity.

This method can be an effective way for investors to reduce their tax burden while still benefiting from ongoing income. It also provides an opportunity to align financial planning with philanthropic goals.

Choosing the Right Tax Deferral Strategy

The best tax deferral strategy depends on an investor’s financial goals and long-term plans. Working with a tax professional can help ensure compliance with IRS regulations and maximize tax benefits.

Real estate investors may benefit from like-kind exchanges or Delaware statutory trusts to grow their portfolios while deferring taxes. Business owners might prefer installment sales or deferred sales trusts. Those interested in underdeveloped areas may find opportunity zone funds useful, while charitable remainder trusts provide a way to defer taxes while supporting a cause.

Choosing the right strategy requires careful planning, considering factors like filing status, tax bracket, and investment objectives.