Tax Tip of the Week | A Need to Know on Capital Gains Taxes

Generally, capital assets that are held in excess of one year and sold at a profit may be taxed at three (3) possible tax rates: (1) 0%, (2) 15% or (3) 20%. For most people, the rate used depends upon their filing status and the amount of their taxable income. Gains from the sale of capital assets not held for a year are taxed as ordinary income. If capital assets are sold at a loss – generally, only $3,000 ($1,500 married filing separate) may be deducted annually unless other capital gains are available as an offset.

Everyone thinks that Congress designed the zero-percent capital gain rate just for them. That thinking is only natural since so many reporters and so many politicians have over-hyped the catchy expression of “zero-percent rate.” The truth is VERY few taxpayers will ever be in position to take advantage of the zero-percent long-term capital gain rate. To do so, for most single and married couples filing jointly, their taxable income not including the capital gains must be less than $39,375 or $78,750, respectively. Remember your taxable income might include any Form W-2s, interest and dividend income, business and rental income etc. But, it also includes the capital gain itself. So, not a very big window exists for the possibility of qualifying for using the zero-percent rate. If your income other than capital gains, less your deductions exceeds these taxable income ceilings then the window not only shuts but disappears as though it never existed. This capital gain tax calculation is not made the same as the calculation of income taxes which are calculated using the incremental tax brackets. And, depending upon the amount of your regular taxable income not including the capital gains above and beyond the amounts of $39,375/$78,750 - you will then use either the 15% OR the 20% tax bracket for the capital gains rate. Don’t forget the “net investment income tax” of 3.8% which could be an additional tax along with your particular state income tax. Ohio taxes capital gains as ordinary income. Also, technically outside the tax world – various income levels may also affect the amount of your Alternative Minimum Tax (AMT), Medicare insurance premiums and the amount of student loan repayments (if applicable).

More information and explanations follow in the article below by Tom Herman as published by the Wall Street Journal on Monday, June 17, 2019.

                            -Norm Hicks and Mark Bradstreet

By tax-law standards, the rules on capital-gains taxes may appear fairly straightforward, especially for taxpayers who qualify for a zero-percent rate.

But many other taxpayers, especially upper-income investors, “often find the tax law around capital gains is far more complicated than they had expected,” says Jordan Barry, a law professor and co-director of graduate tax programs at the University of San Diego Law School.

Here is an update on the brackets for this year and answers to questions readers may have on how to avoid turning capital gains into capital pains.

Who qualifies for the zero-percent rate?

For 2019, the zero rate applies to most singles with taxable income of up to $39,375, or married couples filing jointly with taxable income of up to $78,750, says Eric Smith, an IRS spokesman. Then comes a 15% rate, which applies to most singles up to $434,550 and joint filers up to $488,850. Then comes a top rate of 20%.

But don’t overlook a 3.8% surtax on “net investment income” for joint filers with modified adjusted gross income of more than $250,000 and most singles above $200,000. That can affect people in both the 15% and 20% brackets. For those in the 20% bracket, that effectively raises their top rate to 23.8%. “That 23.8% rate is the rate we use to plan around for high net-worth individuals,” says Steve Wittenberg, director of legacy planning at SEI Private Wealth Management.

There are several other twists, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Among them: a maximum of 28% on gains on art and collectibles. There are also special rates for certain depreciable real estate and investors with certain types of small-business stock. See IRS Publication 550 for details. There also are special rules when you sell your primary residence.

State and local taxes can be important, too, especially in high-tax areas such as New York City and California. This has become a much bigger issue in many places, thanks to the 2017 tax overhaul that included a limit on state and local tax deductions. As a result, many more filers are claiming the standard deduction and thus can’t deduct state and local taxes. But some states, including Florida, Texas, Nevada, Alaska and Washington, don’t have a state income tax. Check with your state revenue department to avoid nasty surprises.

How long do I typically have to hold stocks or bonds to qualify for favorable long-term capital-gains tax treatment?

More than one year, says Alison Flores, principal tax research analyst at The Tax Institute at H&R Block. Gains on securities held one year or less typically are considered short-term and taxed at the same rates as ordinary income, she says. The rules are “much more complex” for investors using options, futures and other sophisticated strategies, says Bob Gordon, president of Twenty-First Securities in New York City. IRS Publication 550 has details, but investors may need to consult a tax pro.

The holding-period rules can be important for philanthropists who itemize their deductions. Donating highly appreciated shares of stock and certain other investments held more than a year can be smart. Donors typically can deduct the market value and can avoid capital-gains taxes on the gain. But don’t donate stock that has declined in value since you purchased it. “Instead, sell it, create a capital loss you can use, and donate the proceeds” to charity, Mr. Gordon says. You can use capital losses to soak up capital gains. Investors whose losses exceed gains may deduct up to $3,000 of net losses ($1,500 for married taxpayers filing separately) from their wages and other ordinary income. Carry over additional losses into future years.

If you sell losers, pay attention to the “wash sale” rules, says Roger Young, senior financial planner at T. Rowe Price . A wash sale typically occurs when you sell stock or securities at a loss and buy the same investment, or something substantially identical, within 30 days before or after the sale. If so, you typically can’t deduct your loss for that year. (However, add the disallowed loss to the cost basis of the new stock.) Mr. Young also says some investors may benefit from “tax gain harvesting,” or selling securities for a long-term gain in a year when they don’t face capital-gains taxes.

While taxes are important, make sure investment decisions are based on solid investment factors, not just on taxes, says Yolanda Plaza-Charres, investment-solutions director at SEI Private Wealth Management. And don’t wait until December to start focusing on taxes.

“We believe in year-round tax management,” she says.

What if I sell my home for more than I paid for it?

Typically, joint filers can exclude from taxation as much as $500,000 of the gain ($250,000 for most singles). To qualify for the full exclusion, you typically must have owned your home—and lived in it as your primary residence—for at least two of the five years before the sale. But if you don’t pass those tests, you may qualify for a partial exclusion under certain circumstances, such as if you sold for health reasons, a job change or certain “unforeseen circumstances,” such as the death of your spouse. See IRS Publication 523 for details. When calculating your cost, don’t forget to include improvements, such as a new room or kitchen modernization.

Credit given to Tom Herman. This article appeared in the June 17, 2019, print edition as 'A Need to Know on Capital-Gains Taxes.' Mr. Herman is a writer in New York City. He was formerly The Wall Street Journal’s Tax Report columnist. Send comments and tax questions to taxquestions@wsj.com.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.  

This Week’s Author – Mark Bradstreet, CPA & Norman S. Hicks, CPA

–until next week.