Halfway through your flight, the conversation with the lady seated next to you turns to investing. She asks, “what is a stock spin off, and how long do you have to reinvest to avoid capital gains? You pull down your tray as the steward hands your meal and you tell her this …

How Long Do You Have to Reinvest to Avoid Capital Gains?

How long you have to reinvest to avoid capital gains is dependent on the method used. Capital gains is the difference between the sales price of a stock and the stock’s original purchase price. This monetary excess is the taxable capital gains on the sale of the shares.

Mitigating capital gains tax is achievable, however, tax avoidance is much harder. Addressing the question, how long do you have to reinvest to avoid capital gains? We must examine the primary methods and timelines.

Holding Period – When a stock is held for a minimum of one year and then sold at a profit, the profit (capital gains) is taxed at the long-term capital gains rate. The profits on shares held for less than a year are taxed at the higher short-term capital gains rate. The holding period can mitigate the capital gains tax, but it is not an avoidance strategy.

Favorable Tax Treatment Accounts – Depending on the type of retirement account, capital gains withdrawals can be tax-free.

Roth IRA – This individual retirement account (IRA) allows the capital gains from stock sales to accumulate tax-free and if certain criteria are met, withdrawals of contributions and earnings are free of capital gains taxes, as well. Here are the requirements for qualified distributions:

  • The Roth IRA must be open for five years prior to any withdrawals. The 5-year clock begins on January 1st of the year of your first contribution.
  • You are a minimum of 59½ years old.
  • You are disabled (this is a condition and not a universal mandate).
  • You use the funds to purchase your first home. The lifetime limit is $100,000.
  • Upon your death, distributions are made to your estate or beneficiary.

How long do you have to reinvest to avoid capital gains? As previously mentioned, avoidance is harder than a tax deferral and may require certain conditions and a lengthy holding period.

Qualified Opportunity Fund (QOF) – A Qualified Opportunity Fund is an investment vehicle created to encourage employment opportunities and economic development in low-income communities. These communities are identified as Opportunity Zones by the state and certified by the Treasury Department.

Realized stock sale capital gains can be invested in a QOF within 180 days to defer capital gains taxes. If the investment is held for 5 years, the investor receives a 10% step-up in tax basis equating to a 10% reduction in deferred capital gains tax. A 7-year holding period produces a 15% deferred capital gains tax reduction.

When the QOF investment is held for 10 years, any additional gains generated from the investment are free of capital gains taxes.

How long do you have to reinvest to avoid capital gains? The Roth IRA allows the capital gains on stock sales within the account to accumulate tax-free and tax-free withdrawals under specific conditions. An investment in a Qualified Opportunity Fund (QOF), held for 10 years, is another avenue to capital appreciation free of capital gains tax.

Read next: How are Spinoff Shares Taxed?

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