0% Capital Gains Tax Rate for 2011 and 2012

Linda Stern of Reuters wrote about some of the less well known tax breaks in the proposed tax cut extension legislation before Congress.

Savers, investors could profit from tax bill’s small print

She linked to an analysis of the Senate bill by the Joint Committee on Taxation.

One item of interest to readers of this blog is that the 0% [long term] capital gains tax rate will be extended for two more years, i.e. 2011 and 2012.

How can [long term] capital gains tax rate be 0%? Isn’t it 15%? It’s 15% if you are in 25% federal income tax bracket or above. It’s 0% if you are in the 15% tax bracket or below. For the latter group, the [long term] capital gains tax rate has been zero in 2009 and 2010. Now it’s going to stay at zero for two more years. Sweet!

If you belong to this group, there’s still a limit on how much you can sell and pay zero [long term] capital gains tax. Only those [long term] gains that, when added to your regular income, still put you in the 15% bracket or below are taxed at 0%.

For example, if you are married filing jointly and your taxable income before [long term] capital gains is $40,000, you can generate up to $28,000 worth of [long term] capital gains and not pay any federal capital gains tax, because the top of the 15% federal tax bracket for married filing jointly is $68,000 ($34,000 for single). Note the relevant number is your taxable income, not gross. Taxable income is after all deductions and exemptions.

For a retiree, this is a perfect way to reset the cost basis in one’s taxable account. If you have legacy positions you no longer want but you didn’t want to sell because of [long term] capital gains, you can sell them now and buy what you really want. If you still like the investments, sell and immediately buy back the same positions. No federal [long term] capital gains tax. The tax cost basis will be higher, which means lower [long term] capital gains tax in the future when the rate isn’t zero.

Linda Stern mentioned in her article gifting appreciated stocks (or mutual fund or ETF shares) to elderly parents who are in a low tax bracket eligible for 0% [long term] capital gains tax. When you gift stocks or fund shares, the recipient gets your original cost basis. The elderly parents can sell the shares for a [long term] gain and pay no [long term] capital gains tax. If the parents feel generous, they can make a contribution to your kids’ 529 plan. Just saying …

State income tax can be a spoiler to this nice perk. Most states don’t have a special tax rate for capital gains. If you are in a high-tax state such as Oregon, although federal [long term] capital gains tax is 0%, the state of Oregon will still tax the gains at 9%. But considering it’s normally 9% plus federal [long term] capital gains tax, 9% is still a very good deal.

A reader brought to my attention that it can be more complicated if you receive Social Security benefits. Additional income can make more Social Security benefits taxable. It’s best to estimate the effects of realizing capital gains with a tax calculator. With Intuit’s TaxCaster online tax calculator, I see a couple, both 65 years old, receiving $30,000 in Social Security benefits, can generate $60,000 in long term capital gains and pay less than $500 in federal income tax. What a deal!

I must say our current policies are very friendly to retirees who have more liberty in managing their income. I just hope the policies will stay friendly when I retire.

Reference:

  • S.A. 4753 Tax Relief, Unemployment Insurance Reauthorization, And Job Creation Act Of 2010: Summary, Full Text

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Comments

  1. Bill says

    TFB,

    Question:

    I have $5000 in capital loss carryover going into 2010.

    I sell stock this year for a capital gain of $5000, but I qualify for 0% capital gain tax for the entire amount.

    Does my capital loss carryover get wiped out by this capital gain that is not otherwise subject to tax?

  2. Harry Sit says

    @Bill – It’s wiped out. It means you can generate more gains and pay zero capital gains tax. In my example in the post, if they have a $5,000 capital loss carryover, they can generate up to $33,000 worth of capital gains, versus only $28k without a capital loss carryover.

  3. simplesimon says

    This would be very nice for me as I have big gains due to a low cost basis from tax loss harvesting in 2009 and expecting to have low income in the next couple years due to enrollment in grad school from 2011-2013.

    Now I just need to figure out what’s the best way to minimize taxes and figuring out what my tax bracket is going to be from realizing capital gains, converting a traditional 401k/IRA to a Roth IRA, or a combination of both.

    I just thought about it and I think it might be better in the long run to do the traditional to Roth conversion as much as I can in the low tax bracket vs realizing capital gains and paying 0% taxes. Thanks for the heads up, great read!

  4. Harry Sit says

    @SI – Short term gains have (always?) been taxed as ordinary income. Whenever we talk about a special tax rate for capital gains, we are talking about long term gains. Anyway I added “long term” everywhere just to make sure everyone is clear about it. Thank you.

  5. Kasey says

    If you repurchase right away (not waiting 30 days), it would be a wash sale. Then, wouldn’t you have to pay short term capital gains?….I thought wash sales are no no’s.

  6. Harry Sit says

    @Kasey – Wash sale applies only when you sell at a loss. If you realize a long term gain, there’s no wash sale if you repurchase the same investment immediately.

  7. Bostonian says

    Regarding impacts of unearned income on one’s social security, I just asked this question of the SSA last week. I was told that it was only one’s wages, if they exceeded a certain limit (say $14,100), that would start being taxed if they exceeded a certain limit, and one hadn’t reached full retirement age. Beyond that age there was no limit on income from wages in terms of making SS payments taxable, So, can you please explain?

  8. Harry Sit says

    @Bostonian – The SS agent is correct. If you are not yet at your Normal Retirement Age and you receive Social Security, for every $2 you earn in wages or self-employment income (not capital gains as in the subject of this post) above $14,160, your SS benefits will be reduced by $1. See How Work Affects Your Benefits. After you reach your Normal Retirement Age, you won’t be penalized for your wages. Either way, capital gains don’t count in this calculation.

    However, regardless of your age, if you generate too much in capital gains, your Social Security benefits can become taxable. That’s different from the scenario of SS benefits being reduced for having wages. Use the TaxCaster tax calculator I linked in this post to find the sweet spot of realizing capital gains and still pay minimum taxes.

  9. aew says

    What happens if you go over the 15% bracket by $2000.00 ? Do you loose the 0%tax break completely,or would you be taxed only for the $2000.00 you went over?

  10. Harry Sit says

    @aew – It depends on how you go over. If your capital gains make you go over, you don’t lose the 0%; you just pay taxes on the excess. If your non-capital gains make you go over, you don’t get the 0% to begin with.

  11. James H. Bentley says

    My local income tax preparer has stated that the interpretation you place on capital gains taxes may be in error, and that she simply follows what the IRS states is the tax on capital gains and/or dividends. That is, all capital gains (long term) and dividends are taxed at 15%, no matter your tax bracket.

    Since I am retired (and have low income) I would possibly be able to take good advantage of the low “taxable income” bracket you mention. How would you recommend convincing my local preparer that what you say in this article is valid?

  12. Jim Bastinck says

    Does the capital gain from sale of a mixed use commercial bldg (50% my residence) have the same benefits you refer to for a low income retiree?
    Thanks for your reply.
    jim

  13. Jim B says

    My wife’s aunt’s husband died last year and she has a couple of rental homes she is trying to sell to make ends meet.

    Will she have to pay capital gains taxes on these when she sells?

  14. Leo says

    James H. Bentley on January 18, 2011

    My local income tax preparer has stated that the interpretation you place on capital gains taxes may be in error, and that she simply follows what the IRS states is the tax on capital gains and/or dividends. That is, all capital gains (long term) and dividends are taxed at 15%, no matter your tax bracket.

    - – - – - – -

    James, you need to change your tax preparer. Since he/she is wrong on this, they may be wrong on many things.

    Look at the Capital Gain Tax Worksheet on page 37 of instructions for form 1040. It clearly shows that any LTCG is non-taxed if your otherwise taxable income is below $68,000 for joint return.

  15. Mark Thomas says

    I own my own business and pay myself less than 15,000.00 per year. It is an inn so I have no over head persay from me. I am selling the inn and will get a gain of 400,000.00

    How much capital gain taxes will I have to pay? I have been told everything from zero to 20 percent.

    Thank you.

  16. douglas drake says

    Hi,
    thanks for your info. I filled out the capital gains tax worksheet on pg 37 and it did indeed work out that I would pay no tax on my cap gains!
    However, you are only supposed to use that worksheet if you have a collectibles gain or partnership gain as per schedule D lines 18 and 19!!!
    is that weird or what?
    there must be a way around that.
    thanks for your help!
    Douglas

  17. douglas drake says

    sorry,
    bad math..
    the worksheet on p 37 worked fine once I got the math right.
    No taxes on longterm cap gains if your income is under 34,000!

  18. Jane Evelyn Atwood says

    If I sell my principal residence in France where I’ve been living as an American citizen for 40 years (and paying taxes here in France, while declaring in the USA but paying nothing, as per the law) for a profit of one million euros, do I have to pay capital gains on this profit to the US govt. -? My income here is under 50,000$US.
    Thanks!

  19. G. JOHNSTON says

    I’ve been unemplyed for the better part of 3 years, so my taxable income is well under $34,000.00. If I were to receive a gift of stock of say $250,000.00, would I be able to deduct $34,000.00 from that amount or would I wind up paying the 39.6% short term capital gains tax if I sold the shares immediately?

  20. C Amodio says

    How doses the 0% long term gain tax work if a dependent has total taxable income (income plus capital gains) of less than $15,000? Will this affect me because I claim him as a dependent?

  21. Britt Bigelow says

    I was left $390,000 in stock from my uncle who passed away in 1991 and there is a long term capital gain of $250,000 since then. My taxable income is $0. I gues I could sell $68,000 each year and have no federal long term tax, but what happens if the extension of the 0 goes away and a higher rate takes effect. I also wander if the stock will continue to hold the value it has now.

    Britt who needs to make a decision now

  22. Eleanor Hansen says

    What happens if parents are dead and siblings are selling the family home? What about capital gains?

  23. anon says

    >your taxable income before [long term] capital gains is $40,000, you can generate up to $28,000 worth of [long term] capital gains and not pay any federal capital gains tax, because the top of the 15% federal tax bracket for married filing jointly is $68,000
    >

    What if your LTCG amount to more than $40k in the above scenario? How is the amount over $40k taxed?

    I have no idea if the actual tax form has some arcane way of combining ordinary income and that subject to LTCG in order to determine your ordinary income tax rate bracket, or what.

    What if your ordinary income is in the 25% bracket — in this case are ALL of your LTCG are at 15%? Or is the first $69k of LTCG at 0%?

    Looking at the summary tables of brackets such as at
    http://www.gianttaxhike.com/

    implies that LTCG are “bracketed” at the same dollar amounts as ordinary income?

    My accountant does the taxes & I’ve never had to consider any of this before; but now I want to convert IRAs to ROTHs (ordinary income) and also sell a lot of LTCG; so I need to understand how to do it tax efficiently over this year and the next.

  24. Harry Sit says

    @anon – Additional LTCG beyond the 0% allowance — the difference between top of 15% bracket and the ordinary income — are taxed at 15%. If your ordinary income is already over the top of the 15% bracket, then all LTCG are taxed at 15%.

  25. anon says

    Thanks for clarifying that. Odd that the lowest bracket gets that free lunch; must be aimed at retirees. Might be an interesting story about how it came to be.

  26. Harry Sit says

    @anon – The logic is that LTCG rate is supposed to be lower than the ordinary income rate. For taxpayers in higher brackets, LTCG rate is 10-20% lower. To maintain that preference for LTCG, the LTCG rate has to be 10-20% lower for taxpayers in the lower brackets as well. That drives the LTCG rate to 5% and eventually 0%.

  27. Lyn says

    What happens if you are selling a building (mixed residential/commercial) that you’ve owned 50% of for several years, but 50% of which you acquired under a year ago? Long term? Short term? Mixed?

  28. tmatthews says

    What is the maximum income for head of household with 2 dependents to still receive the 0% rate?

    My landlord wants to buy me out of my lease, probably close to $50K.

    Currently, my net annual income is about $20K.

  29. diane joyce says

    Please help – my aunt, 82 years old, sold a large amount of stock she had been holding onto for over 40 years for $192,000.00, moving it into a safer less risky fund. I estimate the gains on this account to be around 160,000.00. Her pension, social security and bank interest is around 31,000. At what rate will she owe for capital gains and most of all is there anything that can be done to offset the amount? Would a large donation offset the amount owed? Is there anything else she should consider doing? I appreciate your help and thank you in advance for any suggestions that you can offer. Thank you! thank you! diane

  30. Eric says

    TFB

    Filing Status- Single
    Long term capital gain 10,000
    Capital loss carry over $15,000
    Taxable Income $30,000 (included 10,000 capital gain)

    Do I have to use 10,000 capital loss to offset against 10,000 gain to reduce taxable income to $20,000? Or can I save my $15,000 loss carry forward to future years since I will be taxed on $20,000 taxable income anyway because of the capital gain tax exemption?

    Thank you.

  31. John rice says

    I am currently unemployed,and probably will be next year as well. I some capital loss carry forwards. My taxable income may well be zero next year. However, my family is selling a farm we have owned for over 100 years, which I expect will generate @ $700,000 in long term capital gains to myself. no one knows for sure what the rate will be in 2013,apart from the Obamacare surcharge being added. Will the fact that I have no “earned taxable income”keep me from being pushed into the higher bracket as Obama promised, or should I expect to pay full boat, whatever that may be?

  32. Harry says

    John – Nobody knows what the law will be in 2013. That’s the problem. Under the current structure, for someone without much ordinary income, after a set amount taxed at 0% in 2012, the rest of the long-term capital gains are taxed at 15%. See the chart in this post Reset Cost Basis Higher By Realizing Capital Gains. Come in 2013, that 15% number could be 20% (plus 3.8% for excess over $250k), or it could be something else. For gains as large as $700k, it’s worth spending some money consulting a CPA to see what’s the best way to do it.

  33. Ron says

    I am a Washington resident. I held some bank stock of an Oregon Banking Corporation, and sold it for a long term captial loss a few years ago. This year, 2012, I sold my share of a real estate partnership, . based in Oregon, for a long term capital gain. I have enough loss to wipe out the gain at the Federal level. But my preparer doesn’t seem to think that I can use the stock loss to offset the gain at the stale (Oregon) level. I am a NON-Resident of the State of Oregon.

    Any suggestions? Thanks

  34. Harry says

    Ron – Sorry I don’t know anything about Oregon taxes. When you are a non-resident, states usually have you do a return on your full income and then take a % of the tax based on your in-state income as of % of your total income. If Oregon does it that way, it’s conceivable your loss can’t offset your income at the state level.

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