The 0% long-term capital gains tax rate has been around since 2008, and it lets you take a few steps to realize tax-free earnings on your investments. Harvesting capital gains is the process of intentionally selling an investment in a year when any gain won't be taxed. This occurs in years when you're in the 0% capital gains tax bracket.
How the 0% Rate Works
In tax year 2021, the 0% tax rate on capital gains applies to married taxpayers who file joint returns with taxable incomes up to $80,800, and to single tax filers with taxable incomes up to $40,400.
There can be years when you'll have less taxable income than in others. You can sometimes make a low-tax year occur on purpose in retirement by choosing which accounts to take withdrawals from each year.
0% capital gains rates apply only to long-term capital gains on assets you've held for more than one year. If you hold assets for one year or less, your capital gains are taxed at your income tax rate.
Capital Gains Tax Opportunities
Let’s say you’re married and your taxable income this year, calculated after subtracting your itemized deductions or standard deduction, is going to be about $60,000. You have about $20,400 of room for more income before you hit the 15% long-term capital gains bracket.
You have a tax-planning opportunity if you own stocks or mutual funds in a non-retirement account and some of them have unrealized long-term gains. You can exchange your investment for something similar so your portfolio allocation and risk tolerance stay about the same, and that unrealized gain now becomes a realized gain. You could have up to $20,400 of realized gains and pay no income tax on them in this example.
How To Harvest Your Capital Gains
There are several tips you should know as you consider reaping the benefits of your capital gains.
- Mutual funds distribute capital gains at the end of each year. The gains will likely be minimal if you own tax-managed funds or index funds, but funds that aren't managed with taxes in mind can generate large gains. You should find out what this gain will be before you intentionally realize additional gains.
- Check your tax return to see if you have a capital loss that's being carried forward from a previous year. Check with a tax professional if you're not sure or can't tell. Past losses can carry forward indefinitely. They're first used to offset gains, then up to $3,000 of a capital loss can be used to offset ordinary income if you have no gains. Your gains will first use up all your old losses if you have capital losses that are being carried forward and you realize gains.
- Make sure you have an accurate estimate of what your tax situation for the year. It's best to work with a tax professional or a financial advisor for these projections unless you're at least somewhat investment-savvy. You might also run multiple scenarios through online tax preparation software to help you do your planning.
Benefits of Harvesting Gains for Retirees
Gain harvesting can be an effective way to realize tax-free gains, but you must build a habit of projecting taxes and looking for tax opportunities by the end of each year to make it work. You can reduce your tax bill during your retirement years by doing this consistently, which means more of your retirement income goes in your pocket.
A miscalculation could be a costly mistake, so get help from a professional if you're at all unsure of your taxable income.
Frequently Asked Questions (FAQs)
Do capital gains count as income?
Capital gains will count toward your adjusted gross income for tax purposes. Capital gains income can bump you up into a higher tax bracket if you earn enough through investing and trading.
What is the capital gains tax rate on stocks held one year or less?
Short-term capital gains are taxed as normal income at your normal income tax bracket rate.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.