For tax years beginning in 2013, the 20% long-term capital gains rate applies to taxable incomes > $400,000 ($450K joint return). With an increase tied to limiting the effect of itemized deductions, known as the Pease limitation, a taxpayer’s rate increases by ~1%. There is also a new 3.8% flat tax on net investment income, resulting in a total equivalent capital gains rate of ~25%.
- Spread capital gains over multiple years if possible; also consider increasing deductible retirement plan contributions.
- Although itemized deductions from Schedule A do not reduce AGI (used to determine the extra taxes described above), things such as capital losses, rental property expenses, alimony payments, HSA contributions, health insurance premiums, and IRA contributions do help. Income from municipal bonds and Roth IRA distributions will not hurt; converting a traditional IRA to a Roth IRA will hurt.
- A taxpayer with “air pockets” has greater flexibility. The tax code allows shrewd taxpayers to take advantage of income, deductions, and long-term gains if the right strategy is used. For example, a retired couple with $70,000 of AGI before capital gains and $30,000 of itemized deductions will have taxable income of about $40,000. This leaves the couple with an “air pocket” of about $33,000 before they go from a 0% rate to a 15% rate on long-term gains. If the gain turns out to be $50,000, the first $33,000 will not be taxed, and the $17,000 will be hit with the 15% rate. If the $50,000 gain in this example were split over two years, the capital gains liability would be zero.
- People in a 0% income tax bracket can harvest gains and pay zero capital gains over multiple years.
- People in a 0% income tax bracket can harvest gains and pay zero on donated assets but still take a near-full deduction for the gift, up to certain limits.
- Making family gifts of assets about to be sold is another valid strategy. By gifting up to $14,000 a year (2013 annual limit without eating into one’s lifetime exemption of $5.25 million) per donee, the donor can gift partial or full interests in specific capital gains assets. Once the gifting is completed, the asset is sold for a gain, and the donor’s income only increases by the amount of the portion remaining, if any. The balance of the tax is paid by the donee.
- Installment sales mean a gain may be spread out over multiple years. Up to $250,000 of gains from the sale of a primary residence is tax-free ($500,000 if married). Only an amount above these limits is subject to capital gains tax.
- The new 3.8% tax on capital gains and other investment income takes effect on trust income not distributed if trust AGI is just $11,950+, a huge difference from the $200,000 (single) to $250,000 (joint return) limits for individuals.