Granted, this is not a strategy that everyone will be able to use. But… if you are one of the few who could take advantage of a completely legal way to pay ZERO in taxes, wouldn’t you want to know about it?
So now that I have your attention, what am I talking about? Well, first the basics: as you probably know, when you sell an investment for a gain, you typically have to pay taxes on the gain you capture when you sell. In tax terms, that’s called a “capital gain,” and it’s taxed differently than other income. And if you owned the asset (think stocks, mutual funds, real estate, etc.) for at least one year, you get what’s called “long-term capital gain” rates, which are currently 15-20%.
However, a little known fact is that over the last 10 years or so, long-term capital gains tax rates for those in the lowest two tax brackets have dropped significantly. Originally, President Bush’s Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003 lowered it to 5%, and then a few years later that change was lowered even further to 0%. This was initially a temporary piece of legislation, but Congress made it permanent in the American Taxpayer Relief Act of 2012 (signed by President Obama in January of 2013).
However, for most people who have investment assets, and therefore have to think about capital gains, the rate is 15-20%, because the lowest two brackets are quite low, in terms of income. For 2014, the brackets are as follows:
|Married Filing Jnt||Ordinary Inc||Capital Gains|
(Remember, your tax bracket is based on your “taxable income,” which is after all your itemized deductions, IRA contributions, etc.)
So what does all this mean? Well, the 0% capital gain rates can create a unique planning opportunity for just the right situation. Here’s an example: Let’s say you’re in your early 60s, have saved aggressively, and are planning to retire. You’ve made a nice income over the years that has put you solidly in the 25% or above brackets. Most of your nest egg is in tax-preferenced 401k, IRA, or Roth IRA accounts. But fortunately, your late uncle left you some Apple stock about 10 years ago, that you never sold. Now, it has grown to a sizable amount, but to sell it you would have to pay 15-20% in capital gains, plus state taxes.
The bottom line is–you want to diversify this position, without shelling out for the taxes.
One option that may work for you, assuming all the other “stars align,” is to try to capture that capital gain in a low income tax year. So, you retire at the end of the year before so that no income bleeds over into the current year. Then, delay taking social security and any other pension benefits for one year. In most if not all cases, and definitely in the case of Social Security, those benefits will go up due to the fact that you deferred them an extra year. You also delay taking any withdrawals from your IRA or 401k accounts. Of course, this only works if you have other sources of cash for daily expenses. Or perhaps you sell the Apple stock on Jan 1, and live off those proceeds for a year.
At the end of the day, if you were planning to retire anyway, this is a strategy that may pay off. If we assume the gain on the stock was $80,000 (for easy round numbers), then you could end up saving $12,000 in taxes (by paying 0% instead of 15%). In my opinion, that makes this a strategy worth looking at.
This is just another example of how having someone who can see the “big picture” of your financial situation can help you take advantage of some really smart planning opportunities.