Clarification on capital gains tax rates

[Retireby45ish]

I stumbled upon the 0% capital gains rate and was thinking that when the time was right for retirement I could simply sell off investments while staying in that 0% and pay little to no taxes. I have most of my investments in taxable accounts.

I came across this calculator that seems to paint the following picture.

Tax Calculator - Estimate Your Income Tax for 2019 - Free!

I figure I need about 90k to live on yearly (myself and wife filing jointly). Probably less but this is our current spend.

Dividends and other income from passive investments = 25k

Long term capital gains = remainder to get to 90k -> 65k

Q1:
It seems like if we stay under the ~80k (2020) threshold of income that all long term gains less than 80k would put me in a tax bracket of 0%.

But then I read another article that states that the gain itself should be counted as income. So that 65k would be added to the 25k as income source. ?? Clearly that changes things since income is now 90k.

Q2:
Also, l have spoken only I terms of the gains. That means you could unlock even more than the 65k needed, since you would have some cost basis to that capital when you sold it. (Ie. sell 65k worth of cash but paid 25k, so only a gain of 40k). Am I correct here?

So now I’m confused. Can someone help clarify this for me.

Thanks!

 

[Dd852]

Death and taxes my friend - can’t escape! Yes, you need to add all income including dividends plus capital gains to see if you go over the 80K barrier. So it is very very difficult to be zero bracketed.

So income of 25 plus a gain of 55 is zero bracketed, $1 more in any category and you’ll pay on the whole gain

 

[Dd852]

And yes to Q2, only the actual gain counts. So if you sell for 155 K but have 100K in basis, that’s a 55 gain but 155 in your bank account

 

[audreyh1]

If you have very low ordinary income - no SS or pension, little taxable interest income, then yes, you might have a large chunk of your long term gains income taxed at 0% rate. We get most of our taxable income from qualified dividends and long-term cap gains distributions, so for very many years we have had a nice chunk of it taxed at 0%.

Between the higher interest rates and the much larger portfolio due to growth that gap has now just about closed.

Definitely the realized gain counts as taxable income, so sell the highest basis shares if you can.

And your passive dividend income - some of that may be qualified dividends and it receives the same tax treatment as long-term gains.

So there is a threshold above which long term gains and qualified dividends are taxed. If your taxable income AGI (which includes realized gains) minus your standard (or schedule A) deduction is under $80,000 for MFJ in 2020, then you have room to add more realized gains and not increase your taxes.

So in your example above of $90K, you still get to subtract the $24K standard deduction, leaving you with $66K of income for the tax computation. Hey, you can take another $14K in realized gains before paying any more tax!

 

[NW-Bound]

In the past, even when I did not need to sell, I still sold some shares and immediately bought them back. That caused the gain to be realized and declared on the tax return, but no tax was due (other than state tax). That served to reset the cost basis higher.

Needless to say, I sold up to the top of the bracket for zero tax for capital gain.

 

[donheff]

It sounds like you are selling $65K in equities to fund your expenses. That will come out to some lesser amount of CGs - maybe $30K? That plus your dividends will leave your income should remain well under $80K. Maybe you should be harvesting a bit more gains to fill the 0% gap before other income producers like SS and RMDs kick in.

 

[JoeWras]

Also don't forget your state taxes, if they apply.

 

[RunningBum]

See if this explanation from Kitces helps: https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

Or this from Bogleheads: https://www.bogleheads.org/wiki/Marginal_tax_rate#Calculation

Or my explanation in a past thread: http://www.early-retirement.org/for...-conversion-this-year-100754.html#post2324709 (look at the post before as well).

Only the gains on your sale are counted in all of this. The basis from the sale is a tax free return of capital.

 

[pb4uski]

I stumbled upon the 0% capital gains rate and was thinking that when the time was right for retirement I could simply sell off investments while staying in that 0% and pay little to no taxes. I have most of my investments in taxable accounts.

I came across this calculator that seems to paint the following picture.

Tax Calculator - Estimate Your Income Tax for 2019 - Free!

I figure I need about 90k to live on yearly (myself and wife filing jointly). Probably less but this is our current spend.

Dividends and other income from passive investments = 25k

Long term capital gains = remainder to get to 90k -> 65k

Q1:
It seems like if we stay under the ~80k (2020) threshold of income that all long term gains less than 80k would put me in a tax bracket of 0%.

But then I read another article that states that the gain itself should be counted as income. So that 65k would be added to the 25k as income source. ?? Clearly that changes things since income is now 90k.

Q2:
Also, l have spoken only I terms of the gains. That means you could unlock even more than the 65k needed, since you would have some cost basis to that capital when you sold it. (Ie. sell 65k worth of cash but paid 25k, so only a gain of 40k). Am I correct here?

So now I’m confused. Can someone help clarify this for me.

Thanks!

You would be fine. The gain is counted as income... so rour total income would be $90k ($25k of dividends and $65k of capital gains).... less the standard deduction of $24k would be taxable income of $66k... well below the $80k hurdle so your total tax would be $0.

In fact, you have some headroom to do $14k of Roth conversions at zero tax too.

And yes, in order to generate $65k of money for spending your gain would be a lot less... providing more room for zero or low-cost Roth conversions.... welcome to the wonderful world of early retirement taxation!

 

[Retireby45ish]

Great. Thanks for the help everyone!

This is still a few years away for me but I’m already trying to factor all this in so I can decide how the tax implications of FIRE will affect my decision to retire early.

Follow up question:

For ACA, to receive a subsidy your income must stay below a certain amt (400% threshold max). Since you just explained to me that that gains count as income and I correct in assuming that if I keep my cost basis down I can still qualify for the subsidy..

Example:

25k income (dividends)
65k selling investments (100% appreciation = 32.5k basis, 32.5k gain)

Total income = 25k + 32.5k gain = 57.5k.

So I could still qualify for some subsidy, correct?

If so, i guess the question is: is it better to keep income low to qualify for maximum ACA subsidy or harvest more gains to get close, but stay under, that 80k level.


This, of course, assumes ACA is still using this method in a few years.

 

[RunningBum]

Yes, in your example you would qualify for a subsidy.

Whether to harvest more gains or get a larger subsidy is a case by case basis. IIRC the benefit of taking less income for a bigger subsidy is about 10% on every extra dollar less. Compare that to a 15% benefit to no tax on LTCGs if you stay under that limit.

But it's not straightfoward. The ACA subsidy may not always be there, and you might be able to harvest those gains at 0% later. Or you can put appreciated funds in a DAF (Donor Advised Fund) for your charitable giving. Or you can keep it through your whole life and pass them on to your heirs, who get a stepped up basis.

Also, if you can keep your income at 250% of FPL, you can qualify for cost savings reductions. I have never qualified for that so I don't know how much that is worth but it seems like a good thing to me unless medical issues are a rare thing for you. And of course you can't know what the next year will bring.

I do neither. I use the space to the ACA subsidy cliff for Roth conversions. It seems like it's probably a better benefit for me to pay taxes on the deferred income at a lower rate now, rather than a higher rate after I have SS + pension + RMDs.

You can make a case for any of the three (0% LTCGs, larger ACA subsidy, Roth conversion) and the difference between them probably isn't that much. Do a spreadsheet or back of the envelope calculation for which seems to work best for you, and go with it. I don't even know for certain if I'm doing the right thing, and I have all of my information, so I can't get you a definite answer which seems best for you.

 

[Retireby45ish]

See if this explanation from Kitces helps: https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

Or this from Bogleheads: https://www.bogleheads.org/wiki/Marginal_tax_rate#Calculation

Or my explanation in a past thread: http://www.early-retirement.org/for...-conversion-this-year-100754.html#post2324709 (look at the post before as well).

Only the gains on your sale are counted in all of this. The basis from the sale is a tax free return of capital.

Thanks. Very helpful. I found the charts on first link great, as was your bucket analogy.

 

[SecondCor521]

So income of 25 plus a gain of 55 is zero bracketed, $1 more in any category and you’ll pay on the whole gain

The above is incorrect. You would only pay taxes on the portion of your income and capital gains which exceed the relevant thresholds.

Also, if you can keep your income at 250% of FPL, you can qualify for cost savings reductions. I have never qualified for that so I don't know how much that is worth but it seems like a good thing to me unless medical issues are a rare thing for you. And of course you can't know what the next year will bring.

CSRs are quite nice. There are three levels which are at 150%, 200% and 250% of FPL. CSRs are based on estimated income, and are not reconciled at tax time. At 200%, the CSR makes the silver plan an 87% plan actuarially, so you get a close-to-platinum plan for the cost of a subsidized silver plan. To get CSRs you have to buy a Silver plan.

 

[pb4uski]

Great. Thanks for the help everyone!

This is still a few years away for me but I’m already trying to factor all this in so I can decide how the tax implications of FIRE will affect my decision to retire early.

Follow up question:

For ACA, to receive a subsidy your income must stay below a certain amt (400% threshold max). Since you just explained to me that that gains count as income and I correct in assuming that if I keep my cost basis down I can still qualify for the subsidy..

Example:

25k income (dividends)
65k selling investments (100% appreciation = 32.5k basis, 32.5k gain)

Total income = 25k + 32.5k gain = 57.5k.

So I could still qualify for some subsidy, correct?

If so, i guess the question is: is it better to keep income low to qualify for maximum ACA subsidy or harvest more gains to get close, but stay under, that 80k level.


This, of course, assumes ACA is still using this method in a few years.

At the most if you did additional gains you would save $3,375 ($80k - $57.5k = $22.5k... * (0% now vs 15% later) = $3,375.

So if your ACA subsidy is less than $3,375 a year then you would be better off forgoing ACA subsidies and doing more gains. IME ACA subsidy will likely exceed $3,375/year.

Another factor to consider that is my strategy... if you don't need to touch that taxable money then it gets a stepped up basis when you pass so the total appreciation is tax-free.