Learn how the Tax Cuts and Jobs Act of 2017 allows tax-free capital gains in Non-Retirement accounts for some taxpayers, and determine if you qualify.
Get the Advantage of an IRA…without an IRA
The primary advantage of all kinds of IRA accounts is the way taxes are calculated.
For Traditional IRAs the growth is taxed when you make withdrawals, which is generally during retirement. Assets that grow inside a Roth IRA are never taxed again if you follow the rules.
Everybody knows that the disadvantage of Non-Retirement accounts is that growth is taxed when it happens, right?
Well… not always.
For some taxpayers it is actually possible to grow your investments tax-free, even in a Non-Retirement account. This article will help you understand if you might be eligible to realize gains in a Non-Retirement account without having to pay any taxes.
The Rules for Tax-Free Capital Gains
Something magical happened in the Tax Cuts and Jobs Act of 2017 for investors with modest incomes: a new 0% capital gains tax bracket was created.
Starting in the 2018 tax year, if you are in the 10% or 12% income tax bracket, then any long-term capital gains you realized throughout the year are taxed at 0%.
That means: if you meet certain income limitations, you can harvest gains in your Non-Retirement investment accounts and pay zero federal capital gains taxes.
Figure Out Your Income Tax Bracket
To determine if you can benefit from this new tax law, the first step is to determine your income tax bracket. If you are in the 10% or 12% tax bracket, then your capital gains tax rate is 0%.
To determine your income tax bracket, you need to know your taxable income. There are two ways too do that.
The first way is to grab last year’s tax return. Line 10 on your 1040 is your Taxable Income. You can adjust that number up or down based on if you think you will make a little more or a little less this year.
The second way is to calculate your total income and subtract off your deductions. Most filers take the standard deduction, which is about $12k for single-filers, and about $24k for married-filers.
If your taxable income is less than about $40k for single-filers, and about $79k for married filers, then you will likely qualify for the 0% capital gains tax rate.
To keep is simple, here is the math:
Single Filer: $52k (gross) – $12k (deductions) = $40k (taxable)
Married: $103k (gross) – $24k (deductions) = $79k (taxable)
That means, in general, a single-filer can earn up to $52k gross income and be eligible to pay 0% capital gains taxes. And, married-filers can earn up to $103k and also be eligible. (These numbers are scheduled to increase every year)
Of course, these are general numbers and assume standard deductions. Your situation will be unique, so consult a tax professional before making any decisions.
Only Long Term Capital Gains
This is not the first time that certain types of capital gains have been exempt from federal tax. There are similar exceptions for your primary residence. And, just like your house, there are specific rules you have to follow to qualify.
You can avoid capital gains tax on your primary residence if you have lived there more than two years and the gain is less than $250k (single) or $500k (married).
Similarly, you can avoid capital gains tax on investments if you have held them for more than one year, and your income is low enough to qualify for the 10% or 12% bracket.
Remember: short-term gains on assets owned less than a year are taxable as income. Bond dividends are taxable as income. Certain options contracts are taxable as income.
Every transaction in your Non-Retirement account is reported and assessed separately by the IRS. That means that some transactions might be tax free and others might not.
This is different from IRAs because none of the transactions inside an IRA are even reported to the IRS. They do not care if you buy and sell stocks inside your Retirement account. IRA accounts are treated as a whole by the IRS, and only transfers in and out are even reported.
So, to qualify for this 0% bracket, every transaction is treated separately. And, every transaction has to qualify as long-term capital gains.
The point of all of this is: figuring out if your transactions qualify for 0% tax is fairly advanced. But, its totally worth it to find out.
The way capital gains are taxed has changed dramatically and often over the last 100 years. Sometimes rates go up. Sometimes they go down.
Tax law changed in 2018. Now, some taxpayers can realize some capital gains outside IRAs and pay $0 federal capital gains. It is worth the effort to determine if you are one of those tax payers.
There is no way to know how long this tax loophole will exist. Best to take advantage of it now, if you can.
This new tax loophole can benefit investors who need to rebalance to keep their portfolios in check.
It can also reduce the downside of using a RoboAdvisor in Non-Retirement accounts.
Always consult a tax professional before making any potentially taxable financial decisions.
I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.