Taxation of LTCGs during retirement

[Sandy & Shirley]

We are going to pay off our mortgage this year, so, we are thinking about starting a standard brokerage account for the creation of LTCGs. As we understand it, LTCGs are tax free income as long as we are in the 12% Federal tax bracket. Yes, we know that each dollar of our LTCGs gains will make 85 cents of SS taxable.

So, back to our question! Line 16 of Schedule D merely adds your long and short term gains together, then puts that number on your 1040SR form line 7.

What forms or instructions or … etc. are used to count the LTCGs for the taxation of your SSB, but not count the LTCGs for your Tax Due calculations, until your combined income is over $100 less than the top of the 12% bracket.

Also, and this is what we will eventually be aiming for, how do you fill out what forms when we have $15,000 of LTCGs and $5,000 of STCLs?

Thanks in advance for any feedback on this question.

 

[pb4uski]

I use TurboTax so I can't really tell you the forms or instructions.

What I and many others do is just a download for income and capital gains transactions from the broker and then just review it to see if it makse sense compared to our statements and 1099 forms.

The tax calculations do separate tax calculations for ordinary income and for preferenced income (qualified dividends and LTCG).

 

[Sunset]

I use H&R Block software and it does it all behind the scenes.

Next year I'll use TT software.

To me, it's not worth the effort of getting the forms and reading the instructions to complete the taxes properly like it was done before tax software was available.

 

[SevenUp]

What forms or instructions or … etc. are used to count the LTCGs for the taxation of your SSB, but not count the LTCGs for your Tax Due calculations, until your combined income is over $100 less than the top of the 12% bracket.

In the 1040 Instructions, see p. 32 for the "Social Security Benefits Worksheet" and p. 36 for the "Qualified Dividends and Capital Gain Tax Worksheet".

If you aren't using a version of tax prep software that allows you to see a filled-in version of those worksheets, at least some of the Tax estimation tools - Bogleheads listed in that article will do so.

 

[cathy63]

In the 1040 Instructions, see p. 32 for the "Social Security Benefits Worksheet" and p. 36 for the "Qualified Dividends and Capital Gain Tax Worksheet".

If you aren't using a version of tax prep software that allows you to see a filled-in version of those worksheets, at least some of the Tax estimation tools - Bogleheads listed in that article will do so.

Depending on how exactly your LTCGs are generated, you may also need the Schedule D tax worksheet.

The 1040 instructions for Line 16 will tell you exactly which worksheet(s) to use to calculate the tax that applies to your situation.

 

[SecondCor521]

What forms or instructions or … etc. are used to count the LTCGs for the taxation of your SSB, but not count the LTCGs for your Tax Due calculations, until your combined income is over $100 less than the top of the 12% bracket.

@cathy63 answered this.

Also, and this is what we will eventually be aiming for, how do you fill out what forms when we have $15,000 of LTCGs and $5,000 of STCLs?

To report the LTCG and STCL, that is done on Schedule D. In certain cases, you may also need to complete Form 8949. You fill them out per the instructions. ;-)

Roughly speaking, short term stuff goes on the top half of Schedule D, long term stuff on the bottom half of Schedule D, then the second page combines them and calculates what goes to the 1040 and what should be carried forward.

To calculate the taxes owed, you'll need to either complete the worksheet in the Form 1040 instructions near the line for the tax calculation, or the one in the Schedule D instructions, as @cathy63 already mentioned. (And, of course, the SS worksheet to determine how much of your SS is added to your gross income.)

Hopefully you're not aiming for STCL, but they happen sometimes anyway.

...

As an aside, since I know you are knowledgeable about the SS tax hump, you probably also would be interested to read and learn about the 27% phantom tax bracket which might bite you in the circumstances you're contemplating. Forewarned is forearmed and all that.

 

[Dash man]

Each year if I have any short term or long term capital losses, I use them to offset my gains as much as I can. If you have more losses than gains, you can use that to offset up to $3,000 of other income each year and carry the rest forward. Just be aware of any wash sale rules where to take the tax loss on a stock, you can’t have purchased that stock/fund within thirty days before and thirty days after the sale date. It also applies to a substantially identical asset.

 

[SecondCor521]

Each year if I have any short term or long term capital losses, I use them to offset my gains as much as I can. If you have more losses than gains, you can use that to offset up to $3,000 of other income each year and carry the rest forward. Just be aware of any wash sale rules where to take the tax loss on a stock, you can’t have purchased that stock/fund within thirty days before and thirty days after the sale date. It also applies to a substantially similar asset.

[Emphasis added.]

It's not that you can't purchase the stock in that window. It's just that, if you do, then some of your capital loss gets deferred.

Also, the IRS standard, while they have yet to define it, is substantially identical.

 

[scrabbler1]

As others have described, you use 2 worksheets found in the tax booklet. First, you use the SS Benefits worksheet which determines how much of your SS benefits are taxable. This will include all dividends, qualified or otherwise, and all cap gains, both short-term and long-term. At this point, it makes no difference how any of this income is later taxed. This amount will be shown on Line 6b.

Second, once you have determined your taxable income on Line 15, you will use the Qualified Dividends and LTCG worksheet which will determine what your taxes due are, shown on Line 16.

 

[SecondCor521]

Second, once you have determined your taxable income on Line 15, you will use the Qualified Dividends and LTCG worksheet which will determine what your taxes due are, shown on Line 16.

As @cathy63 mentioned in post #5, in certain circumstances you have to use a similar but different worksheet in the Schedule D instructions.

 

[Sandy & Shirley]

Thank you for your replies so far.

We are currently withdrawing $25,696 from our IRAs, paying 22.2%, $5,705 in Federal Taxes and 7.75%, $1,991 in State and Local Taxes, to end up with $18,000 so we can pay $1,500 every month for our mortgage.


Our mortgage will be paid off in November of 2023 and these are the Marginal Tax Rates that we are hoping to create in 2024 and beyond.

Our LTCGs will be generated by investing in relative “Fixed Income” stocks, watching them grow for 53 weeks, then cashing them in for LTCGs, then transfer the return of capital and LTCGs from his/her standard brokerage account to her/his brokerage account to re-purchase the stock we just sold! Along the way, if we see one of our stock symbols failing (hope this doesn’t happen) we can sell it for a STCL and invest in a different symbol.

Normal Capital Losses are limited to $3,000, but the way I see the form, they would now be limited to all of our LTCGs plus $3,000 with a carry over to the next year. I think, and it is a big think, that, in a single year, we could create $15,000 in LTCGs and $5,000 in STCLs, then, if the forms are like we hope they are, take the $5,000 off of the IRA withdraws at 22.2% and declare the entire $15,000 as LTCGs at just 10.2%.

Like I said, we will pay off our mortgage in 2023 and then start this wild tax ride in 2024. That is why we are looking for all of the advice and answers on exactly how our Gains and Losses will be taxed in the Future.


We will continue to investigate what has been suggested so far. We do have plenty of time before our new investment strategy can be started.


Thanks again for the advice given so far.

 

[pb4uski]

... Our LTCGs will be generated by investing in relative “Fixed Income” stocks, watching them grow for 53 weeks, then cashing them in for LTCGs...

Can you elaborate on these "fixed income" stocks? Provide a few tickers?

 

[SevenUp]

I think, and it is a big think, that, in a single year, we could create $15,000 in LTCGs and $5,000 in STCLs, then, if the forms are like we hope they are, take the $5,000 off of the IRA withdraws at 22.2% and declare the entire $15,000 as LTCGs at just 10.2%.

Sorry to be the bearer of bad news but line 7 of Form 1040 will be $10,000. The STCL is first applied against the LTCG on Schedule D. See lines 7, 15, and 16 on that schedule.

 

[SecondCor521]

SevenUp is correct in the post above this one.

then cashing them in for LTCGs, then transfer the return of capital and LTCGs from his/her standard brokerage account to her/his brokerage account to re-purchase the stock we just sold!

No need to do any transfers. Unlike with capital losses which have the wash sale rule, you can sell to realize a LTCG (or STCG) then rebuy the same stock one millisecond later in the same account and there are zero problems to doing so. And you can do so with 1000 different stocks in a single day if you like.

...

By the way, the current tax brackets and rates expire 1/1/2026 unless Congress passes additional legislation. (I think they'll pass additional legislation, but have no idea what they'll come up with.)

 

[Sandy & Shirley]

Can you elaborate on these "fixed income" stocks? Provide a few tickers?

Sorry for using the wrong term, I meant to say “Growth Stocks”, and that is probably the wrong term also. Let me give you a couple of examples from money.cnn.com.

Again, I am new to this. I am a 75 year old computer and math geek. So far in retirement we have been living just below what I refer to as our Marginal Tax Humps where our Federal rates will jump from 22.2% to 40.7%. We have also been living with a $1,500 a month mortgage payment, which will end in November. All of our retirement savings is currently in IRA accounts, about 70% of it in Roth accounts.

So the question is what we should do with our extra available income each year starting in 2024. Doing my math geek thing, the idea of paying 10.2% on that extra income instead of 22.2% seems like a reasonable goal. SO, plan A is to start standard brokerage accounts for each of us and look for reasonably secure “Growth Stocks” which we can convert each year into LTCGs.

The first thing we have to do over the next 9 months is to find the best sources for reasonably secure “Growth Stocks”. We are not looking for the stock symbols that will double or triple next year “IF” A, B, and C happen. We are looking for solid companies that generally grow with the economy or maybe just a tad faster than the economy.

So that is my next question to the group, where should we start looking for that list of stock symbols?

 

[SevenUp]

We are looking for solid companies that generally grow with the economy....

So that is my next question to the group, where should we start looking for that list....

Perhaps FSKAX, SCHB, or VTSAX?

 

[Sandy & Shirley]

Thanks SevenUp, I will add those symbols to my list to research, but I am also looking for on-line sources of individual stocks from multiple analysts.


I have 9 months to do research on paper to see which source of stock recommendations is best. Our available "extra money" will not start until January of 2024.

 

[Exchme]

Sandy & Shirley:

As Morningstar reports every quarter, even professional fund managers do not do individual stock picking well enough to beat their benchmarks by enough to cover their costs and fees long term. We amateurs lack research staffs, banks of computers and armies of PhDs are very unlikely to beat the appropriate benchmarks long term at all.

By picking just one market sector ("Growth"), you are taking another risk that you don't need to take. Just buying a Total Market fund diversifies away individual stock risk and sector risk, so is less likely to crash and burn. Generally speaking, if you use a Total Market fund for your stocks and want higher portfolio risk for some reason, you can just change your stock/bond allocation and still avoid individual stock and sector risks.

A broad market fund is also much simpler. Many of us can expect to lose our mental sharpness as we age, who is going to make all the complex transactions playing with individual stocks then?

I don't see the advantage in your capital gain generation plan. As I read your posts, once your mortgage is paid off this year, you will have more free cash flow from RMDs + SS than your spending needs, so you will start a taxable account. Your plan is to sell annually to generate LTCGs, subjecting more of your SS to taxes. You would only gain from these taxes if you eventually have to liquidate your new taxable account. If you never have to liquidate, you've paid taxes for no purpose.

 

[cathy63]

... Again, I am new to this. I am a 75 year old computer and math geek. So far in retirement we have been living just below what I refer to as our Marginal Tax Humps where our Federal rates will jump from 22.2% to 40.7%. We have also been living with a $1,500 a month mortgage payment, which will end in November. All of our retirement savings is currently in IRA accounts, about 70% of it in Roth accounts.

So the question is what we should do with our extra available income each year starting in 2024. Doing my math geek thing, the idea of paying 10.2% on that extra income instead of 22.2% seems like a reasonable goal. SO, plan A is to start standard brokerage accounts for each of us and look for reasonably secure “Growth Stocks” which we can convert each year into LTCGs...

You're still going to have IRA withdrawals because you're over the RMD age. Are those amounts going to be less than what you have to take now to afford your mortgage?

Your SS is still going to be taxable to some extent. If you can lower your IRA withdrawals, then less SS becomes taxable initially, but every Cap Gain you realize in a taxable account is income that just moves more of that SS back into the taxable category.

I believe you know all that, but it leads me to ask why you are trying to create all these cap gains every year if you don't even want the income? That's exactly what the old saying about "letting the tax tail wag the dog" refers to.

Why not just invest the RMDs that won't be paying the mortgage into index funds and plan to hold them for many years? If you need that money fifteen years from now to pay for something like long term care, sell the funds. You'll realize the cap gains then, but you'll also have a ton of deductible medical expenses to offset them. If you hold your investments until you die, then your heirs get a step-up in basis and the cap gains evaporate.

 

[aja8888]

Capital gains in this market environment are not guaranteed. We may have 10+ years of stagnant (or even negative) growth. Remember, the makeup of the country's GDP has a high percentage of government spending, not business creation.

 

[Sandy & Shirley]

Sandy & Shirley:

... Your plan is to sell annually to generate LTCGs, subjecting more of your SS to taxes. You would only gain from these taxes if you eventually have to liquidate your new taxable account. If you never have to liquidate, you've paid taxes for no purpose.

The entire purpose is to create another Tax Free account and pay minimum taxes in doing so.

The first deposit of let’s say $10,000 will be made with 22.2% withdrawals from our IRA account.

Hopefully, year 1 will result in a 10% LTCG which will be withdrawn and taxed at only 10.2%. The Tax Free (return of capital) size of the account is now $11,000. Year 2 we might add another $9,000 of 22.2% IRA capital for a total of $20,000. Then, if we can create 10% LTCGs we will again only pay 10.2% tax on those gains bringing us to $22,000.

We will be making smaller and smaller 22.2% IRA withdrawals each year while creating larger and larger 10.2% LTCGs as our Tax Free (return of capital) investments grow.

 

[scrabbler1]

As @cathy63 mentioned in post #5, in certain circumstances you have to use a similar but different worksheet in the Schedule D instructions.

I encountered that when I was doing my (snake-bit) friend's 2021 taxes. He had a small amount of Unrecaptured 1250 Gain income which was part of one of his smaller mutual fund holdings. It was a PITA to modify my tax spreadsheet to include a lot of extra lines from the expanded worksheet, just to affect his taxes due by a few dollars. I was quite relieved to see that mutual fund not have any of these unusual cap gains in 2022, so I could return to the shorter, simpler spreadsheet.

 

[SevenUp]

...which will be withdrawn and taxed at only 10.2%

Marginal tax rates do come in many different amounts, but it isn't clear how you get 10.2%. Can you explain that?

 

[pb4uski]

Marginal tax rates do come in many different amounts, but it isn't clear how you get 10.2%. Can you explain that?

12% * 85% since each $1 of 0% LTCG causes 85c of SS to become taxable at 12%.

 

[SevenUp]

12% * 85% since each $1 of 0% LTCG causes 85c of SS to become taxable at 12%.

Yet another marginal tax rate that one won't find in Form 1040 instructions.