When investors think about building long-term wealth, they often focus on returns: finding great companies to invest in, allocating assets wisely, and staying invested. But there’s another powerful tool that may significantly impact your long-term results: tax deferral.
The ability to defer capital gains taxes may dramatically increase the growth of your assets. In many ways, it functions similarly to a 401(k) and you can think of it as receiving an interest-free loan from the government.
The Power of Deferring Capital Gains
When you sell a business, real estate or an investment for a profit in a taxable account, you typically owe capital gains tax on the appreciation. Depending on your income and state of residence, this can range from roughly 15% to more than 30%. Washington currently imposes 7% tax on capital gains above $250,000, which increases to 9.9% on gains above $1,000,000, subject to exemptions and potential changes in law. Tax rules vary by jurisdiction and may change.
Whether it be stocks, a business or real estate, each time you sell a portion of your capital is siphoned away and that money can no longer earn a return for you.
If you were able to delay paying those taxes— the money that would have gone to the IRS stays invested and continues compounding.
Over long periods of time, compounding on the full pre-tax amount can meaningfully increase wealth.
Why Tax Deferral Is Similar to a 401(k)
Many investors intuitively understand the value of tax deferral inside retirement accounts.
When you invest in a traditional 401(k):
- Contributions are made pre-tax
- Investments grow tax-deferred
- Taxes are paid only when funds are withdrawn
Because taxes are deferred, the entire amount stays invested and compounds for years or decades.
The same concept applies to capital gains deferral in taxable accounts. If you avoid triggering gains, the capital that would have been paid in taxes remains invested.
In both cases, the core advantage is identical:
The longer taxes are deferred, the longer your capital compounds.
Think of It as an Interest-Free Loan from the Government
Another helpful way to think about tax deferral is that it’s like receiving an interest-free loan from the government.
Imagine you have a $1,000 gain and would owe $200 in taxes if you sold today.
If you don’t sell:
- That $200 remains invested
- It continues compounding along with the rest of your portfolio
- In effect, the tax liability remains deferred, allowing more capital to stay invested and compound until the gain is eventually realized.
Over time, the growth on that deferred tax liability can become substantial.
The Role of Tax-Aware Managed Accounts
Tax-aware managed accounts are designed to help investors minimize realized gains and strategically harvest losses which is called tax-loss harvesting.
What Is Tax-Loss Harvesting?
Tax-loss harvesting involves:
- Selling investments that are trading at a loss
- Realizing the loss for tax purposes
- Reinvesting in a similar asset to maintain market exposure
These realized losses can then be used to:
- Offset realized capital gains
- Reduce taxable income (up to $3,000 annually in many cases)
- Carry forward losses to future years
By generating losses that offset gains, investors may have better flexibility in managing when gains are realized. Tax-loss strategies must consider wash sale rules and other tax regulations.
An Additional Advantage: Step-Up in Basis
Tax deferral becomes even more powerful when combined with an important feature of the U.S. tax system called the step-up in basis.
When appreciated assets are passed to heirs at death, current U.S. tax law generally allows the cost basis to be adjusted to the asset’s fair market value at the time of death, commonly referred to as “step-up in basis”.
This means:
- The original capital gain may never be taxed.
- Heirs inherit the asset at the new value.
- They can sell immediately with little or no capital gains tax owed.
Tax deferral can be a powerful estate planning tool to maximize the transfer of wealth.
The Bottom Line
Deferring capital gains is one of the most powerful and often overlooked tools for long-term wealth building.
Like a 401(k), tax deferral allows investments to compound before taxes are paid. And like an interest-free loan from the government, it lets you keep money invested that would otherwise be paid in taxes today.
By combining this principle with tax-aware managed accounts, investors can extend the benefits of deferral even further by helping their portfolios grow more efficiently over time and potentially after death.
Compounding is powerful, but compounding with tax efficiency is even more powerful.
Explore our financial planning strategies to see how tax-efficient investing fits into a broader wealth plan.
Disclosures:
This material is for informational and educational purposes only and should not be construed as investment, tax, or legal advice. Tax laws are complex and subject to change. Investors should consult their tax professional regarding their specific circumstances.
Tax-aware investment strategies, including tax-loss harvesting, do not guarantee tax savings and may increase transaction costs or affect investment performance.
Estate planning strategies should be discussed with qualified tax and legal professional.
All investments involve risk, including the potential loss of principal. Past performance is not indicative of future results.
Opal Advisors, LLC is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training. Please refer to our Form ADV Part 2A and Form CRS for additional information about our services, fees, and conflicts of interest.
