With a tax planning opportunity for just about everything, seeking to pay 0% on capital gains is no exception. There are quite a few planning strategies you can do to realize tax-free earnings on profits from capital assets.
When you sell a capital asset, such as your home or investments (stocks, bonds, mutual funds, exchange-traded funds), you either realize a gain or a loss. Those capital gains are subject to a levy on the profit received from the sale and usually taxed at a lower marginal rate than ordinary income. Any asset held for longer than a year is considered a long-term capital asset and taxed at rates of 0%, 15%, and 20% when sold.
If you buy and sell a capital asset for profit in under a year, this transaction is considered a short-term capital gain and typically taxed as ordinary income. If you experience a loss, the bright side is that up to $3,000 can be deducted annually against your ordinary income.
So, how do you qualify for the 0% capital gains tax rate? For single filers, taxable income below $39,375 will allow you to qualify. If you’re married filing jointly, income of less than $78,750 will also allow you to qualify you for the 0% tax bracket. Most people, however, will fall into the 15% capital gains rate (up to $434,550 filing single and up to $488,850 married filing jointly). Any amount above those thresholds lands at the highest 20% capital gains rate.
Since most people fit somewhere in the middle, how can you leverage tax strategies to fall into the lowest bracket? The most common opportunities exist either when a taxpayer is temporarily unemployed or experiences a fluctuation in income, or if a person is between the ages of 55-75 years old and looking to retire soon (or in retirement).
Due to COVID-19, many taxpayers could be anticipating a lower annual income than in previous years and may consider tax planning opportunities that weren’t on the table before. Let’s say for example, you are married filing jointly and anticipate $65,000 of taxable income after taking the standard or itemized deductions this year. If you own investments outside of your IRA accounts that have unrealized long-term gains, you still have $13,750 before you reach the 15% capital gains bracket. Since there are no rules about future investments, you could realize the gains at a 0% capital gains rate and buy new shares within the same company or even invest in a new company; you could use the gains to put a down payment on a new home or pay for college tuition. Those $13,750 in unrealized gains just became $13,750 in realized gains, and you didn’t even have to pay taxes on them.
The capital gains calculation on home sales—specifically primary residences—is treated a bit differently than realizing gains from investments. The same capital gains rates apply, but there’s a serious exclusion available that may help you avoid paying any taxes on your gains at all. A single filer can exclude up to $250,000, and a married couple may exclude up to $500,000 on profit from the sale of their home, if they have lived in the residence for at least two of the past five years.
One of the most important ingredients in calculating capital gains tax on real estate is the taxable gain is not just based on the purchase price of your home; it’s founded on the cost basis, which means that the higher your cost basis, the smaller your tax burden will be. If you have put hundreds of thousands of dollars into renovating your home, you can add up those home improvement costs and tack them onto the purchase price to get the cost basis of your home.
For example, if you purchased a downtown Newburyport home for $1 million and renovated it for another $500,000 (bringing the cost basis up to $1.5 million), lived in it with your spouse for two of the past five years, you could turn around and sell it for $2 million without paying any capital gains taxes on the sale of the property.
Those examples are only a few strategies to get your tax position at a 0% capital gains rate for the sale of capital assets. If you’re looking for creative tax planning opportunities or have any questions, contact me at stu@erocktax.com or call the office line at (781) 247-5569.
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About Stu: With more than 30 years of experience as a tax professional, Stu Steinberg brings a broad depth of knowledge to his work with his clients. Stu founded Erock Tax to help provide tax and financial planning strategies to individuals, families and small businesses and is passionate about empowering his clients through education about their money health. Stu is highly energetic and brings a sense of optimism, creative problem-solving and a deep level of commitment to every Erock client.