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Capital gains rates are dropping to 0 percent

Thinking about selling an investment? Here's a reason you might want to wait: Starting next year, some lucky people will get to take capital gains for free.

By Helen Huntley, Times Personal Finance Editor
Published December 9, 2007

Thinking about selling an investment? Here's a reason you might want to wait: Starting next year, some lucky people will get to take capital gains for free.

"I've always had a hard time recommending buying or selling just because of the tax impact, but that's a pretty nice perk for waiting a few weeks," said Mark Steber, vice president of tax resources for Jackson Hewitt.

The long-term capital gains rate drops to zero in 2008 for taxpayers who are in the 10 or 15 percent tax bracket. That covers taxable income (after subtracting exemptions and deductions) of up to $31,850 for singles and $63,700 for married couples filing jointly. Next year's numbers will be a little higher with the annual inflation adjustment.

This is a great break for retirees who have low incomes and lots of stocks, bonds and mutual funds that have gained in value over the years. The break also applies to qualified stock dividends.

Retirees won't be the only beneficiaries. By taking income in 2007 instead of 2008 and deferring deductions to 2008 (maybe making that charitable contribution in January), you might qualify for tax-free gains in 2008.

Originally some people thought they'd be able to get the tax break by transferring appreciated assets to children, who would qualify for zero capital gains. Congress put the kibosh on that. Starting in 2008, the "kiddie tax" will apply until children reach age 18, or 24 for full-time students unless they have earned income to cover more than half their support. Children's investment income largely will be taxed at their parents' rate.

An alternative is to transfer assets to other relatives, such as elderly parents, said Mark Luscombe, principal analyst at CCH Inc.

He said anyone who qualifies for the zero tax and has appreciated securities should consider selling them even if they turn around and buy them right back. In that situation, the new cost would become the tax basis for a future sale.

The zero capital gains rate will be in effect through 2010. Unless Congress extends it, rates will revert to pre-2003 levels in 2011 - 10 percent in lower brackets, 20 percent in higher brackets.

Details

For a married couple filing jointly, based on 2007 tax brackets:

If income plus capital gain is below the cutoff for the 15% bracket, your gain is tax-free.

Taxable income $20,000 Net capital gain $30,000 Gain taxed at 0% $30,000

If income before capital gain is above the cutoff for the 15% bracket, your gain is fully taxable.

Taxable income $65,000 Net capital gain $30,000 Gain taxed at 15% $30,000

If income is below the cutoff before capital gain but above it when the gain is included, the gain is partly tax-free.

Taxable income $20,000 Net capital gain $60,000 Gain taxed at 0% 43,700 Gain taxed at 15% 16,300

What to do

Any increase in income has potential consequences, so you might want to talk to a financial adviser before taking a big gain.

To avoid a big increase in total income, consider substituting capital gains for other income. For example, sell stocks in a taxable account instead of withdrawing money from a tax-deferred account (such as an IRA). If you're on the brink of retirement, you might delay starting Social Security benefits, increasing your future benefit amount.

Watch out for stealth taxes. Your capital gain will be included when calculating how much of your Social Security benefits will be taxable. That means more taxes unless you are at the maximum (paying tax on 85 percent of your net Social Security benefits). In addition, the extra income could increase your Medicare Part B premium.

You might lose tax deductions or social service benefits if capital gains put you over income thresholds.

This is an opportunity to rebalance portfolios. Some people hang on to securities that no longer make sense for their needs because they don't want to pay taxes. If you're able to take taxes out of the equation, you can focus on other investment concerns.

Be prepared to hunt down records to determine the tax basis for investments you're thinking of selling. Remember that any reinvested dividends become part of your cost.

[Last modified December 7, 2007, 21:50:08]