Tax opportunities present themselves at every level of income. Although for most tax brackets we recommend avoiding realizing capital gains, if you are in the 0% capital gains bracket, we have a completely different recommendation.
In 2013, capital gains taxation became very complex. Now, there are at least four different tax rates: 0%, 15%, 18.8% and 23.8%.
Capital gains tax works like most progressive taxes. The capital gains you realize stack on top of one another, filling the brackets and progressing into higher and higher tax rates.
The difference is that your taxable income fills up the brackets first. Although not incurring any capital gains tax itself, your income is used to set your starting bracket location. Then, net realized capital gains for the year is placed on top of this income base and the capital gains tax calculated.
Realizing a large amount of capital gains all in a single year is a bad idea. It can push your capital gains tax quickly into higher rates. Conversely, realizing some of the gain each year can keep your taxes relatively low while achieving the same goal.
Now for 2015, the 0% capital gains rate limit is $37,450 for single taxpayers and $74,900 for married filing jointly. That means that, if your income is higher than this threshold, all your capital gains will be taxed at higher rates. However, if your income is lower, you are in the 0% capital gains bracket and can realize some capital gains without paying any tax.
You can calculate how much capital gain you can realize in the 0% by subtracting your income from the limit. By trimming your gains every year up to the top of the 0% bracket, you can gradually realize your gains and avoid paying any tax.
This opportunity does not last forever. As you receive a greater salary, your taxable income will push you out of the zero percent capital gains tax bracket and force the 15% bracket on any realized capital gains.
Additionally, as taxable accounts grow in value, there comes a point when your account is appreciating faster than you can realize gains. Over time, the small opportunities will grow too big and the gains you realize will increase your tax bill.
When gains do get too big, you can consider gifting the highly appreciated stock if you are already charitably inclined. When gifted to a charity, the charity pays no capital gains tax. This saves the donor from selling the stock, paying the capital gains tax, and then having to give a smaller remainder to the charity.
A similar tax strategy can be used with gifts to family members. When gifted to another individual, the recipient assumes the cost basis from the original owner. This means that you could also use highly appreciated stock as gifts to friends or family in lower capital gains brackets than you.
Although it may cost 15% or more of the gain for you to sell it, if you gift the stock to someone in the 0% bracket, when they realize the gains they would incur no tax.
There is a so-called kiddie tax that subjects children to their parents’ tax rates which extends all the way to age 23 if they are a full-time student or earning less than half their support. However, adult or independent children can receive appreciated stock in their own capital gains bracket.
Finally, there may be an opportunity to realize capital gains in the 0% after retirement and before Social Security or required minimum distributions begin.
Careful tax planning can avoid much of the capital gains tax. Intentionally realizing capital gains while in the 0% bracket is yet another way to keep your taxes low.
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