10 Ways to Reduce Taxes on Your Brokerage Account

Main takeaways

• Lowering the amount of taxes you pay on your non-retirement assets should involve a mix of strategies.

• Holding investments for more than a year can qualify you for lower long-term capital gains tax rates.

• Tax-loss harvesting lets you offset investment gains or even reduce ordinary income taxes.

• Investing in index funds, passive ETFs and municipal bonds can help minimize your taxable income from investments.

Investing through a standard brokerage account can be an effective part of your financial plan—especially if you’ve maxed out your retirement plan contributions or you need access to funds before you leave the workforce.

But in order to hold onto more of the money you earn from these accounts, you do need to invest with an eye on the tax implications. Here are some effective ways to make that happen.

1. Hold onto your investments longer

Long-term capital gains—the ones you get from investments held for more than a year—are taxed at a lower rate than short-term capital gains. With long-term gains, you’ll owe 0%, 15% or 20% on the amount that your securities appreciate, depending on your income level. But gains from assets held less than a year are taxed at your ordinary income tax rate. In other words, you hold on to more of your earnings when you exercise a little patience.

2. Use tax-loss harvesting

Tax-loss harvesting involves selling investments that have lost value to offset the gains from other investments that you accrued during the same tax year. You can then use these losses to offset up to $3,000 of ordinary income per year, with any additional losses carried forward to future years.

Suppose, for example, that you received $5,000 in capital gains from the sale of a particular stock. If you sell mutual fund shares in that same year that lost $3,000 in value, you now only have to pay tax on the $2,000 net gain.

The wash sale rule prevents you from buying a “substantially identical” security within 30 days before or after the sale when you use tax-loss harvesting. But that means you only have to wait a month to get back the same asset you owned previously.

3. Invest in tax-efficient funds

Consider investing in tax-efficient mutual funds or exchange-traded funds (ETFs) that minimize capital gains distributions. These actively managed funds are focused on tax minimization, which can make a huge difference if you have money in a plain old brokerage account.

One of the reasons that index funds are incredibly popular is that they buy and sell stocks less frequently than most actively managed investments, which translates into fewer taxable events. But tax-efficient funds go a step further, employing tax-loss harvesting and avoiding dividend-paying stocks to keep your tax liability as small as possible.

4. Take a look at municipal bonds

Municipal bonds are issued by state and local governments and are often exempt from federal income taxes. Additionally, if you invest in munis offered by your state of residence, the interest may also be exempt from state and local taxes.

Bond issuers know this, of course, so they offer interest rates that are slightly smaller than other, non-deductible debt offerings. If you’re in a higher tax bracket, the tax benefits of a muni outweigh those stingier yields—but that’s probably not the case if you’re subject to a lower ordinary income tax rate.

5. Choose where to put your assets carefully

As a general rule, place tax-inefficient investments (bonds and dividend-paying stocks) in tax-advantaged accounts, while placing tax-efficient investments (index funds and ETFs) in your taxable accounts.

That way, your brokerage account is mostly generating long-term capital gains, which benefit from a relatively low tax rate. Meanwhile, your tax-deferred 401(k) and IRA accounts absorb whatever interest and dividend income you receive, resulting in a smaller tax bit for the year.

6. Donate securities that have increased in value

Gifting appreciated stocks or mutual funds directly to charity can be more tax-efficient than selling them first and donating the cash proceeds. By donating securities, you avoid paying capital gains tax on the appreciation of your assets and still receive a charitable deduction for their fair market value.

7. Utilize qualified dividends

If they meet certain criteria, the IRS allows corporations to classify their investor payouts as “qualified dividends.” Why does that matter? These qualified dividends are taxed at the lower long-term capital gains rates rather than ordinary income rates. So investing in corporations that pay qualified dividends—and most U.S. companies do—can reduce your tax liability compared to non-qualified dividends.

8. Beware of fund distributions

The IRS requires mutual funds to pass along income and capital gains they receive to shareholders. If you buy a mutual fund right before this distribution is made, you'll owe taxes on it—even though the amount was already reflected in the price you paid for your shares. To avoid paying unnecessary taxes, make sure you only buy mutual fund shares after the distribution date.

9. Set up a donor-advised fund

A donor-advised fund allows you to receive an immediate tax deduction on your contribution and specify which charities will receive the fund’s assets over time. This approach can be particularly useful in high-income years as a way to reduce your tax liability while making good on your philanthropic goals.

10. Time your trades wisely

Selling stocks within a year of your purchase is rarely ideal from a tax perspective. But if you absolutely have to realize short-term capital gains, think about its impact on your tax bracket. For instance, if you need cash during the next calendar year but expect to be in a higher bracket then, consider selling your shares in the prior December instead.

The upshot

Reducing your tax liability from a brokerage account requires a mix of strategies tailored to your financial situation and goals. By utilizing strategies like tax-loss harvesting and investing in tax-efficient funds, you can dramatically increase your net returns. For more complicated needs, consult with a financial advisor or tax professional to create a personalized plan that maximizes your tax savings while aligning with your investment strategy.