The one you are most familiar with is known as tax loss harvesting. It's where you sell losers to offset the gains of winners. You don't pay taxes because you didn't gain anything. That pretty much sucks but as a tax strategy it's effective.
But there's another way you can have gains and still pay ZERO on the capital gains.
You have probably heard that long term capital gains are taxed at either 15% or 20% depending on your marginal tax rate for ordinary income. If you are in the 25%, 28%, 33%, or 35% brackets then you pay 15%. If you are in the 39.6% bracket, you pay 20%.
If you're in the 10% or 15% tax brackets – you pay ZERO PERCENT in capital gains.
Where's the top end of the 15% bracket? $37,650 for single filers and $75,300 for married filers for 2016.
Add back in the standard deduction of $6,200 for single filers and $12,400 for married filers and your ceiling on the 15% bracket is $43,850 for single and $87,700.
Add back personal exemptions, which are $3,950 a piece, and now you're talking!
Family of four would get $15,800 personal exemptions lifting the ceiling to $102,000.
When you go to sell investments, whatever gains you would get that remain under that $102,000 ceiling after adding in your income would be tax free.
As we near the end of the year, check to see what your tax rate on long term capital gains might be. If it's 0%, it might be a good time to harvest some of those gains tax free.
That's how you avoid paying capital gains on long term investments. And you don't have to be wealthy to do it!
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Nice post Jim.
Since long term capital gains and qualified dividends are taxed at the same rate, if your family of four generates $102,000 in annual qualified dividend income, they would pay no tax to the Federal Government.
Thanks for the tax advice! I would also like to add that someone can lower her taxable income as well by contributing to a Traditional IRA or 401K, which could potentially lower her into a different tax bracket.
Yes there are a few strategies you can use to lower your taxable income and that’s one of my favorite!
Being married certainly helps in this regard.
Additional strategies: Tax Loss Harvesting allows to you take gains without tax if you exceed the income limit (for the 15% tax bracket) in a future year. If you’re under the limit, by all means Tax Gain Harvest to take some free gains while staying under the limit.
Give appreciated equities to charity. You don’t pay capital gains taxes, and neither does the charity. They disappear. Beats giving cash, hands down.
Death. There is a stepped up cost basis at death (although that’s been threatened to be rescinded by the federal government recently). Not the greatest strategy, but it is effective.
Dying – the world’s oldest tax avoidance strategy. 🙂
I’ve been reading about this strategy over at Go Curry Cracker. Very interesting. So if I take a career break to do some travelling, and make very little in income that year, and sell off investments and sell my house that year, then I would owe no capital gains on either! That’s the plan for now anyway. I hope to talk to a tax advisor about this sometime. My questions are: 1) So the investments have to be at least a year old or else they count as short term capital gains, right? 2) And the investments that I sell count as capital gains and also are taxed as income for that year? That doesn’t seem right. But that could work ok as I plan to travel to low cost of living countries.
You can get tax free gains no up to $250,000 on a house if you’ve lived in it two of the last five years. $500,000 if you’re married (you and spouse each get $250k).
As for your questions:
1. Yes, they have to be at least a year old or it’s short term. Short term capital gains are taxed as ordinary income.
2. They are long term capital gains and taxed as capital gains. They’re considered income but not ordinary income. Income is a big category and not all income is taxed the same. Ordinary income is taxed at the tax brackets most people are familiar with. Your capital gains are taxed only at the capital gains rates, not both.
Good tips, Jim. I managed to fit into the 0% capital gains rate a couple of times in the last few years. It was beautiful because we had some good real estate gains during that time.
Real estate investing adds a few more interesting angles to this.
A lot of my income comes from rental properties, and this income is sheltered by depreciation. So if I make $50,000 in rental income but also have $50,000 in depreciation (paper expense), I have $0.00 income carried forward to my personal tax return from my business return. This was in part how we could get below that ceiling and then strategically sell some properties without paying capital gain.
Even if I did have to pay capital gains on the real estate, I could also use a 1031 tax free exchange to replace one property with another of similar kind and just move my basis to the new property. This also avoids depreciation recapture, which can’t be avoided in the scenario above. I think depreciation recapture is taxed at ordinary income rates and capped at 25%.
Isn’t real estate fun??? 🙂
So paying back the depreciation is taxed as ordinary income? So if you took $5,000 a year in depreciation and had the property 5 years essentially $25,000 is taxable at your ordinary income rate? Assuming you netted $40,000 on the property the $40,000 would be tax free and JUST the $25,000 in depreciation your paying back would be taxed at your current income bracket 10 or 15%?
It appears depreciation recapture is taxed at 25%, thought I knew this already but no matter what bracket your in, its still 25% I assume?
Great advice, Jim. Im not as knowledgeable in long term investments so I appreciate the sweet and straight to the point advice!
No one knows everything and never much when you start out, just slowly accumulate knowledge and before you know it you’ll know more than you realize. 🙂
I thought personal exemptions and standard deduction applies only against the earned income, not investment income from dividends and capital gains.
Nope, it’s applied to all income.
Awesome idea Jim. However, there is no such thing as tax free or 0% in Canada. I wish I could take advantage of this idea.
Well, there are benefits and drawbacks to living in any nation. 🙂