Gone4Good
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
- Joined
- Sep 9, 2005
- Messages
- 5,381
So which is better at lowering your lifetime tax burden: a Roth IRA Conversion or exploiting the 0% Capital Gains bracket?
Say we have a hypothetical taxpayer who is in the 15% bracket and can earn $20K more in income before they move into the next bracket. This person has $100K invested in a traditional before-tax IRA and also has $100K in unrealized capital gains.
What should they do?
1) Convert $20K of the IRA into a Roth. Pay $3K in taxes this year but avoid future taxes on all subsequent investment returns and any taxes that would have been due on withdrawals or RMDs.
2) Sell enough assets to generate a $20K capital gain to take advantage of the 0% gain bracket and immediately repurchase the asset (there’s no wash rule for realizing gains) thereby stepping up the tax basis and forever avoiding paying taxes on that $20K.
On the surface taking the gain seems like the obvious answer. Paying no taxes forever is better than paying some taxes today. And this is almost certainly mathematically correct if our investor completely liquidates their portfolio over their lifetime.
But if they don’t liquidate their entire portfolio, they may never pay taxes on some of those unrealized gains anyway. Stepping up the basis may not save that much in future taxes after all.
I recognize that there is probably no right answer to this question. But is one answer more right than the other?
Say we have a hypothetical taxpayer who is in the 15% bracket and can earn $20K more in income before they move into the next bracket. This person has $100K invested in a traditional before-tax IRA and also has $100K in unrealized capital gains.
What should they do?
1) Convert $20K of the IRA into a Roth. Pay $3K in taxes this year but avoid future taxes on all subsequent investment returns and any taxes that would have been due on withdrawals or RMDs.
2) Sell enough assets to generate a $20K capital gain to take advantage of the 0% gain bracket and immediately repurchase the asset (there’s no wash rule for realizing gains) thereby stepping up the tax basis and forever avoiding paying taxes on that $20K.
On the surface taking the gain seems like the obvious answer. Paying no taxes forever is better than paying some taxes today. And this is almost certainly mathematically correct if our investor completely liquidates their portfolio over their lifetime.
But if they don’t liquidate their entire portfolio, they may never pay taxes on some of those unrealized gains anyway. Stepping up the basis may not save that much in future taxes after all.
I recognize that there is probably no right answer to this question. But is one answer more right than the other?