Rebalancing? Deploying to a combat zone in 2008? Here's a tax trick...

[Nords]

Spouse found an interesting article in the June 2008 magazine of The Naval Reserve Association (motto: "No, no, we're the other NRA!"). It's written by their VP for legal affairs, LT Marc Soss.

Most veterans are familiar with this part:

"Deployed service members ... serving in a combat zone, for any part of a month, will have all their military pay excluded from gross income. The combat zone pay will not appear as wages, tips, or other W-2 compensation. In addition the allowances for subsistence, quarters, travel, and family separation pay received on account of overseas assignments will not be taxable income. This will allow deployed service members to both receive their pay/allowances and maximize the sale of long-term capital gain assets without fear of rising above the 15% income tax bracket and zero [long-term] capital gains tax rate."

This implies that:

"To take maximum advantage of the tax rate, taxpayers should... sell appreciated assets in a taxable account. The taxpayer will be free to immediately repurchase the sold capital asset since the 'wash sale' rules are not applicable to capital assets sold at a gain."

So sell-cycling a stock or fund that's worth $20/share with a long-term cost basis of $5/share could wipe out $15/share of cap gains without paying any tax, and reset the cost basis to $20/share.

This works even without deploying to a combat zone. A married couple filing a joint return will be inside the 15% tax bracket with taxable income up to $65,100. After they account for personal exemptions, standard (or itemized) deductions, and deductible IRA contributions they may actually be able to have a higher taxable income and still be in the 15% tax bracket.

Here's the point that still confuses me. Let's say that a married couple predicts that they'll have $70K of taxable income and $20K of deductions/exemptions. This puts them in the 15% tax bracket with a 0% tax rate on long-term capital gains. I believe that they're able to realize an additional $65,100-($70K-$20K) = $15,100 of capital gains that would not be taxed.

But please correct me if I'm wrong!