New capital gains rate: zero |
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For retirees, a major potential problem is that asset sales to take advantage of no capital gains taxes could actually increase their tax liability.
"There are some pitfalls," agrees Harrison-Suits.
"Retirees drawing Social Security, when they initially figure their
taxable income, may well be below the limits. But as their capital
gains go up, so does the amount of Social Security that might be
taxable. So we have a real tax planning issue that has to be looked
at in a lot of different ways."
"You do need to look at what it might do to the rest of your income," says Scharin. "While you might avoid the capital gains tax, it could raise your adjusted gross income and that may cause more of your Social Security benefits to be taxed or it could potentially affect other deduction phaseouts."
However, because the no-tax rate is in effect through 2010, it gives qualifying taxpayers some maneuverability.
One option, says Harrison-Suits, is rather than selling all your holdings at once, consider incremental sales over the three years that the tax break is in effect.
"Look at your income and determine how much capital gains you can take while still getting the zero capital gains rate," says Scharin. "You might want to sell some this year, another group of shares next year and the rest in 2010."
Rebalancing opportunity
The zero-rate also might enable you to take some tax-free gains and readjust your portfolio's basis.
"In some cases, you may have had some shares of stock you've held for 10 or 15 years and had quite a bit of appreciation in it," says Scharin. "That would make 2008 a good year to sell and then reinvest the gains in whatever else fits your plans."
That's the case for one of DeVine's clients, who have some inherited stocks that have had huge appreciation. "They are early retirees, so they have no Social Security taxes to worry about," he says. "They are in that sweet spot where they can take advantage of basis step-up."
In fact, DeVine's clients and others in the same situation could sell such long-held, greatly appreciated stock and then immediately buy it back if it still fits into their overall investment plans. By doing this, they get a step up in basis, i.e., a greater value of the asset used to calculate gain. When the asset is eventually sold for the final time, the gain and therefore the ultimate tax bill will be less.
And there's no need in this case to worry about the wash sale rule, which prohibits the repurchase of the same or substantially similar stocks that have been sold within 30 days. It applies only to capital losses, not gains.
Lost capital losses
But in some cases, capital losses could be problematic when capital gains are not taxed.
Capital losses must first offset any capital gains. But, when the gain is zero, there is nothing to offset. You could use up to $3,000 of the losses to reduce ordinary taxable income, but essentially in this case, you are wasting the loss' full tax-saving potential since there is no corresponding capital gains.
"People who are eligible for the zero percent rate on capital gain derive no tax benefit from offsetting those gains with capital losses," says Scharin. "If possible, they should defer the losses into a future year when they either have no capital gains or the gains are subject to tax."
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