0% taxes is a beautiful thing. It doesn’t apply to everyone. Let’s discuss.
The Capital Gain rates are 15% (for most) and 20% (for very high income people). Then there’s this pesky 3.8% tax on Net Investment Income if you make over $200,000. Who knew that Capital Gains taxation was so complicated? To clarify, all of this discussion is for LONG-TERM Capital Gains, meaning you held the asset more than 1 year.
That’s the background, so what about this 0% tax rate? If your normal income, what the Internal Revenue Code calls “ordinary income”, keeps you in the 15% (or lower) tax bracket, then you get this 0% Capital Gains tax rate. For SINGLE filers, this means your taxable income must be below $37,650. For MARRIED FILING JOINT, your taxable income must be below $75,300. When I say Taxable Income, I mean after your itemized deductions and after your personal exemptions.
Hey, there are always some catches. Two come to mind.
#1: It’s not like ALL long-term Capital Gains become tax-free. Once your Capital Gain bumps taxable income above those $37,650/$75,300 levels, then you start paying the 15% Capital Gains tax on the excess. Example: Married couple, taxable income without Capital Gain is $65,300. Your Capital Gain is $15,000 pushing your taxable income to $80,300. Result: the first $10,000 of Capital Gain is taxed at 0% and $5,000 is taxed at 15%.
#2: The State of California doesn’t go by these rules. They don’t even have a special rate for Capital Gains. So count on a small amount of state tax.
Example 1. You are 66 years old and debate: start Social Security or wait? Without Social Security benefits, your taxable income would be around $50,000 (married couple). If you take Social Security benefits, your taxable income will be $80,000. By delaying Social Security, you can achieve some tax-free Capital Gains and have your Social Security increase by 8% per year until you start benefits (up to age 70). A double benefit!
Example 2. You own a rental and had a nightmare tenant who left you high and dry. You lost 6 month’s rent and had to pay $20,000 in repairs. Normally your taxable income is around $80,000 but this year it will be less than $50,000. Here’s a window of opportunity to sell part of your mutual fund and take in Capital Gains tax-free. You can buy back into that mutual fund the next day, if you like, and you have now increased your tax basis and lower taxes in the future.
Example 3. You turn 70 ½ this year and must take your “required minimum distribution” from your IRA. This first year of RMD, you can skip and take two distributions the following year (one before April 1). By skipping the RMD, maybe your income is below the magic level and you can take in some 0% Capital Gains.
Those are but a few of the possibilities. Happy hunting for 0%!
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