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It’s natural to fixate on portfolio losses, especially in the S&P500 year down by more than 20%.
But you can still make profits after years of growth, and the profits might qualify for a 0% tax rate depending on your income.
The thresholds can be higher than you expect — even six-figure joint earnings for a married couple, financial experts say.
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Many investors think of two rates for long-term capital gains, 15% and 20%, said Dale Brown, chief executive officer at Salem Investment Counselors in Winston-Salem, North Carolina, which was ranked sixth on CNBC’s 2022 FA 100 list.
But there are actually four rates – 0%, 15%, 20% and 23.8%, with a 3.8% premium for higher earners. “I’ve had clients in the low six figures who didn’t pay taxes,” Brown said.
Here’s how: The tax rates use “taxable income” which is calculated by subtracting the larger of the standard or individual deductions from your adjusted gross income, i.e.
For 2022, you may qualify for the 0% long-term capital gains rate with taxable income of $41,675 or less for single parents and $83,350 or less for joint-filing married couples.
Six-figure earners may qualify for the 0% rate
While a couple that makes $100,000 can safely assume they won’t qualify for the 0% long-term capital gains margin, Brown said investors need to analyze the numbers.
For example, let’s say a retired couple has $30,000 in tax-free interest, $25,000 in regular income, and $75,000 in long-term capital gains and dividends. Your gross income is $100,000 since tax-free interest is not included.
After the standard deduction of $27,000, there remains $73,000 of taxable income that falls within the 0% long-term capital gains tax bracket for 2022.
Part of your income may be in the 0% category
Even if a couple’s taxable income is over $83,350, some of their income can still fall into the 0% long-term capital gains bracket, Brown said.
Let’s say the same retired couple had $30,000 in tax-free interest, $25,000 in regular income, and $100,000 in long-term capital gains and dividends.
In this case, her gross income is $125,000 and taxable income is $98,000. Because the standard $27,000 deduction exceeds $25,000 of regular income, the $98,000 is all long-term capital gains and dividends.
This means that $83,350 will be taxed at the 0% rate and the couple will owe 15% long-term capital gains taxes on the remaining $14,650.
“That’s the benefit of the 0 percent bracket,” Brown said.
Consider the “harvest of tax gains” in the 0% bracket
When the stock market falls, many investors focus on collecting tax losses or using losses to offset other gains.
But you can also try to reap gains if your wealth is still above previous years, said Cory Robinson, vice president and portfolio manager at Tom Johnson Investment Management in Oklahoma City, which ranks 30th on the FA 100 list.
“The upside is there’s no tax, whether it’s dividends or capital gains,” he said, as long as you’re below the taxable income threshold.
That’s the beauty of taking profits. You can reinvest immediately.
Vice President and Portfolio Manager at Tom Johnson Investment Management
For investors in the 0% category, there is an opportunity to reduce taxes on future profits.
Because the taxes are based on the difference between the sale value and the original purchase price, you can sell the profitable asset and buy it back to increase the purchase price.
“That’s the beauty of taking profits: you can reinvest right away,” Robinson said, explaining that investors don’t have to worry about the so-called wash sale rule.
Although the wash sell rule blocks reaped losses if you buy an “essentially identical” asset within the 30-day window before or after the sale, the same rule doesn’t apply to gains, he said.
Harvesting gains in lower-income years
Whether you’re selling assets for income or using a long-term tax strategy, there may be opportunities to make gains in years of lower income, Brown said.
For example, there may be an income gap if you retire but don’t immediately receive Social Security, a pension or pre-tax withdrawals from retirement accounts, he said.
You may also have lower taxable income during a year with a temporary job loss, Brown said.
“The important thing is timing,” Robinson added, explaining the importance of estimating your taxable income before attempting to make profits.
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