How to Use the 0% Tax Rate on Capital Gains
Many can benefit from realizing gains in the right year
Each time we write about the 0% capital gains tax rate, someone says “I didn’t know there was a 0% tax rate on long-term capital gains.” Yes, there is, since 2008.
With planning, there are quite a few things you can do to realize tax-free earnings on your money. Harvesting capital gains is a process of intentionally selling an investment that will have a long-term capital gain in years where that gain will be not be taxed. The gain is not taxed when it occurs in a year where you are in the 0% capital gains tax bracket.
The chart below shows the long-term capital gains tax rates for 2019.
How the 0% Rate Works
For tax years 2018-2025, the 0% tax rate on capital gains applies to married tax filers with taxable income up to $78,750, and single tax filers with taxable income up to $39,375.
Even if your taxable income is normally quite a bit higher, there are often many years where lower income tax years occur, and sometimes you can make a low-tax year occur on purpose in retirement by choosing which accounts to take withdrawals from each year.
The most common tax planning opportunities occur if you are:
- Temporarily unemployed
- A salesperson whose income varies from year to year
- Are between the ages of 55 and 70 and may soon be transitioning into retirement or are already retired
Let’s say you’re married and this year your taxable income (which is calculated after subtracting out your itemized deductions or standard deduction) is going to be about $60,000. You now have room for more income before you hit the 15% capital gains bracket; $18,750 of room to be exact.
If you own stocks or mutual funds in a non-retirement account and some of them have unrealized long-term gains, you have a tax planning opportunity. 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. In this example, you could have up to $18,750 of realized gains and pay no income tax on them.
There are a few things you want to check before you start harvesting gains.
- Mutual funds distribute capital gains by the end of each year. If you own tax-managed funds or index funds, the gains will likely be minimal, but funds that are not managed with taxes in mind can generate large gains. You need to know what this gain will be before you go intentionally realizing additional gains.
- Check your tax return to see if you have a capital loss that is being carried forward from a previous year. If you had past losses those carry forward indefinitely. Losses are first used to offset gains. If you have no gains, then $3,000 of a capital loss can be used to offset ordinary income. If you have capital losses that are being carried forward and you realize gains, your gains will first use up all your old losses. This is ok, but it may not be the best strategy for you.
- Make sure you have an accurate estimate of what your tax return will look like. Unless you are a finance person, it's best to work with a tax professional or financial advisor for these projections, but some enjoy running multiple scenarios through online tax preparation software to do their planning.
Benefits of Harvesting Gains for Retirees
Gain harvesting can be an effective way to get tax-free gains, but in order for it to work, you must build a habit of projecting taxes and looking for tax opportunities by the end of each year. By doing this consistently, you can reduce your tax bill during your retirement years, which means more of your retirement income goes in your pocket.
But be careful. A miscalculation could be a costly mistake. Get help from a professional if you're unsure of your taxable income.
Congress.gov. "H.R.2 — 108th Congress (2003-2004)." Accessed Feb. 25, 2020.
AARP. "Don't Miss Out on Tax-Free Money From Stocks." Accessed Feb. 25, 2020.
IRS. "Topic No. 409 Capital Gains and Losses." Accessed Feb. 25, 2020.
Congressional Budget Office. "Raise the Tax Rates on Long-Term Capital Gains and Qualified Dividends by 2 Percentage Points and Adjust Tax Brackets." Accessed Feb. 25, 2020.
Fidelity. "Mutual Funds and Taxes." Accessed Feb. 25, 2020.
Fidelity. "How to Cut Investment Taxes." Accessed Feb. 25, 2020.