retirement

Time Capital Gains to Trim Tax Tab

The new tax law altered how capital gains and qualified dividends are taxed. It pays for investors to understand the rules.

By now, many taxpayers are aware of most of the significant changes in tax law that took effect this year, including a higher standard deduction and a cap on state and local tax deductions. But the new tax law also refigured the taxation of capital gains and qualified dividends.

Short-term capital gains—that is, profits from the sale or exchange of capital assets held for a year or less—are still taxed as ordinary income. But tax reform lowered ordinary income tax rates, so the tax bill on short-term gains is cheaper, too, topping out at a rate of 37% (the lower rates are scheduled to sunset in 2026).

Long-term capital-gains tax rates remain the same: Profits from the sale or exchange of capital assets held for more than a year are taxed at 0%, 15% or 20%. But before 2018, those rates applied to income-tax brackets. For instance, the 0% rate applied to taxpayers in the 10% or 15% income-tax brackets.

Under the new law, the long-term capital-gains tax rates are based on set income thresholds, instead of income-tax brackets, which were changed by tax reform. For instance, in 2018, the 0% rate applies to taxpayers with taxable incomes under $38,600 for single filers and $77,200 for married couples filing jointly. (The 15% rate is for taxable incomes of $38,600-$425,800 for singles and $77,200-$479,000 for joint filers; the 20% rate, for singles over $425,800 and joint filers over $479,000.) The thresholds will be adjusted annually for inflation. And note, the new tax law didn’t affect the 3.8% surtax on net investment income for singles with taxable income over $200,000 and couples with income over $250,000.

With the income thresholds almost the same as the brackets would have been under the old law, your tax bill on long-term capital gains won’t be wildly different, but you may see some tax savings, according to Barry Picker, a certified public accountant with Picker & Auerbach, in Brooklyn, N.Y. Consider a married couple filing jointly with taxable income of $77,100, including $1,200 of long-term capital gains in both 2017 and 2018. In 2017, the tax on long-term gains would have been $180, he says, while in 2018, it’s zero.

Retirees: Make Use of the 0% Rate

Retirees might trim their tax tab by timing capital gains strategically, says Steven Merrell, an investment adviser at Monterey Private Wealth, in Monterey, Calif. Those who are transitioning from drawing a paycheck to drawing down their portfolios can take particular advantage. “There’s room for some smart tax planning,” Merrell says.

For example, new retirees who have considerably less income than in their working years but significant assets in taxable investments may avoid paying capital gains altogether, he says. Take a single taxpayer who retired and expects to have $24,000 in taxable income before capital gains for 2018. She can realize $14,600 in capital gains without paying any capital-gains tax, because that would keep her within the $38,600 income threshold. If she realizes, say, $30,000 in capital gains, she would increase her taxable income to $54,000 and owe $2,310 in capital-gains tax, because each dollar of long-term capital gain above $14,600 is taxed at the 15% rate, Merrell says. If she instead spreads out the gains over several years to stay within the 0% threshold each year, she could avoid paying any capital-gains tax.

Another potential tax saver: A proposal to index capital gains for inflation is being floated in Washington. If such a proposal were enacted, taxpayers could increase their tax basis in capital assets by the rate of inflation between the purchase date and the time of sale. Let’s say you bought stock in early 2008 for $20,000 and sold it for $35,000 in early 2018. Absent indexing, you would have a $15,000 capital gain. With indexing, your original basis would jump to $23,227, and your gain would be cut to $11,773, lowering your tax bill.

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