The maximum tax rate for long-term capital gains in 2007 is only 15 percent for high-income taxpayers. Seems like a pretty good deal, right? Even better, the rate is a minuscule 5 percent for some lower-income taxpayers. But how low can you go if you really try?
Strategy: Start planning now to reduce taxable income for 2008. If you can keep your taxable income below the magic cutoff point, the tax rate on your long-term gains will hit absolute rock-bottom at zero.
If you play your cards right, you won’t owe any federal income tax on long-term gains when you sell securities and other capital assets in 2008. Alternatively, you might shift some assets to your children to benefit from the zero percent capital gains rate.
Here’s the whole story: Thanks to the tax law passed back in 2003, the maximum tax rate on long-term capital gains was reduced from 20 percent to 15 percent for everyone in an ordinary-income tax bracket above 15 percent. For those individuals in the two lowest ordinary-income tax brackets—the 10 percent and the 15 percent brackets— the rate dropped to 5 percent.
In addition, the 2003 tax law carved out a zero percent capital gains tax rate for those lower-income taxpayers for 2008 only. After 2008, the capital gains rate was scheduled to revert to 20 percent for everyone.
Capital gains rate extended
The Tax Increase Prevention and Reconciliation Act (TIPRA), passed last year, extended those capital gains tax breaks for two more years. Currently, the lower rates will expire after 2010, unless Congress takes further action. So, as things stand now, the zero percent tax rate still takes effect next year and will last through 2010.
What is the cutoff point for the 15 percent ordinary-income bracket? It’s indexed for inflation each year. For instance, the threshold for 2007 is $63,700 for married couples filing jointly ($31,850 for single filers). The top dollar amount should be a few bucks higher next year. If you huff and you puff, you might wriggle underneath the bar in 2008.
You might give generously to charity and push state and local income-tax deductions into 2008. Similarly, you might max out on contributions to your 401(k) or other retirement plan. Then you can cash in on a tax bonanza when you sell appreciated stocks or real estate. But be careful which shares you sell (see chart below).
Remember that you must have held the asset for more than one year to qualify for long-term treatment. The IRS taxes anything less at ordinary income rates. Plus, it taxes long-term gains on certain collectibles such as works of art, at the lesser of your regular rate or 20 percent.
If you don’t have a shot at the zero percent tax rate, don’t despair: You can still shift capital-gain assets to low-taxed family members.
Note: Be aware of storm clouds brewing. A House-passed tax-provision package denies the lowest capital gains rate to dependents who are under age 19, or under age 24 if they are full-time students. We will keep a close watch on the bill’s progress.
Example: Identify low-basis stock
Suppose you bought shares of the same stock at different times and at different prices. Which shares should you sell? It can make a big difference. To fully benefit from the zero capital gains tax rate in 2008, sell the shares with the lowest basis.
Unless you specify otherwise, the IRS will treat the first shares bought as the first shares sold. In other words, it uses a FIFO (First In, First Out) method.
Let’s assume you acquired 100 shares of Global Industries stock at $50 a share in 2004, another 100 shares at $25 a share in 2005 and another 100 shares at $40 a share in 2006. If Global hits $55 a share in 2008, you could decide to sell 100 shares.
Under the FIFO method, you will realize a zero-tax gain of $500 ($5,500 less $5,000 basis). But, if you specify the shares bought in 2005 at $25 a share as the ones you’re selling, your actual tax-free gain is $3,000 ($5,500 less $2,500).
Here’s a chart comparing the results of selling 100 shares from the three blocks of stock.
| Block B
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