3 Tax Breaks Investors Should Strongly Consider

By Maurie Backman Markets Fool.com

The goal of any investor is to make money, but if you're looking at a series of gains, don't be too quick to spend your newfound earnings. Just as the IRS gets a piece of your regular paycheck, so too are you liable for taxes on the money you make from investments. Thankfully, you can lower your taxes even in the face of strong investment gains. Here are a few strategies that can significantly reduce your tax burden.

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1. Hold investments longer

Though you can't get out of paying taxes on most investments, you can lower the amount of taxes you're required to pay by holding your investments for a longer period of time. Investments that are held for one year or less and sold at a profit are considered short-term gains, and as such, are subject to your ordinary income tax rate. This means that if your paycheck is typically taxed 25%, you'll also pay that same tax rate for selling investments you've owned for less than a year's time.

IMAGE SOURCE: GETTY IMAGES.

On the other hand, if you hold your investments for at least a year and a day, you'll bump yourself into the more favorable long-term capital gains category and lower your taxes accordingly. Your long-term capital gains rate is based on the tax bracket you fall into, as follows:

Tax Bracket

Long-Term Capital Gains Tax Rate

10%

0%

15%

0%

25%

15%

28%

15%

33%

15%

35%

15%

39.6%

20%

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DATA SOURCE: IRS.

Now you should know that President Trump has proposed a scaled-down tax system that would reduce the number of individual brackets to just three. If his plan goes through, here's what long-term capital gains tax rates would look like:

Tax Bracket

Long-Term Capital Gains Tax Rate

12%

0%

25%

15%

33%

20%

DATA SOURCE: DONALDJTRUMP.COM.

Either way, you still stand to save a bundle on taxes for holding investments long enough to avoid short-term capital gains. As an example, let's say you typically fall into the 25% tax bracket and make $1,000 from an investment. If you hold that investment for a year or less, you'll pay $250 in taxes. But under both the current and proposed new system, if you hold that investment for a year and a day or longer, you'll pay just $150 in taxes.

2. Sell losses to offset gains

If you have a poorly performing investment taking up space in your portfolio, unloading it might result in a pretty nice tax break. Any time you sell an investment at a loss, you can use that loss to offset capital gains. So if, for example, you make $2,000 from one investment but lose $2,000 on another, your loss will cancel out that gain and spare you from paying taxes on it.

Furthermore, if you're left with a net loss for the year after wiping out your capital gains, you can use that loss to offset up to $3,000 in ordinary income per year. And if your net loss exceeds $3,000, you can carry the remainder to future tax years. So if you have $2,000 in gains for a given tax year but $8,000 in losses, your first $2,000 will offset your gains, the next $3,000 will offset your regular income, and the remaining $3,000 can be carried and applied the following year.

3. Invest in municipal bonds

Municipal bonds -- those issued by cities, states, and localities, as opposed to public corporations -- offer a unique opportunity to earn interest without increasing your tax liability. All municipal bond interest payments are tax-exempt at the federal level, and if you buy bonds issued by your home state, you'll avoid state and local taxes as well.

Corporate bond interest, on the other hand, is always taxable, so if you're looking at $500 a year in interest income from a corporate bond and your effective tax rate is 25%, you'll lose $125 of your earnings to taxes. Buy a municipal bond issued by your home state paying $500 a year in interest, and you'll get to pocket that $500 in full. Keep in mind, however, that while you can avoid taxes on municipal bond interest, you'll still be liable for capital gains taxes if you sell your bonds for a price that's higher than what you paid for them.

We all want to avoid taxes to the greatest extent possible. A few smart investment moves could lower your tax burden and help you keep more of the money you've worked hard to make.

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