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When it comes to long-term capital gains taxes, many taxpayers assume there are just two rates – 15 and 20 percent. However, the IRS has another mostly forgotten rate that allows you to pay nothing on your investment wins. Yes, there’s a 0 percent tax bracket for capital gains. And perhaps more surprising is that many Americans easily qualify to receive it.
Here’s how you can (legally) avoid paying taxes on your capital gains and what to watch out for.
The not-so-secret 0 percent capital gains rate
While it can be easy to overlook, the IRS has clearly laid out how you can qualify for a 0 percent capital gains tax rate, and it’s not that difficult for most Americans to achieve. With increases in 2023 to the standard deduction and tax brackets due to inflation, it’s easier than ever to qualify.
You have two major conditions:
- Your capital gains must be long term
- Your taxable income must be below a certain level, depending on your filing status
Let’s break down what those conditions mean in practical terms.
First, your capital gain must be long term rather than short term. A capital gain becomes long term when you’ve held the asset for at least a year. If you don’t hold it that long, you’ll pay tax at the short-term capital gains rate, which is just the rate for ordinary income.
Second, your taxable income – defined as adjusted gross income minus your deduction, either standard or itemized – must be less than the threshold for long-term capital gains tax rates for your filing status, such as individual or married filing jointly.
The table below shows the thresholds for taxable income to meet the 0, 15 and 20 percent long-term capital gains tax rates.
Long-term capital gains tax rates for the 2023 tax year
|FILING STATUS||0% RATE||15% RATE||20% RATE|
|Single||Up to $44,625||$44,626 – $492,300||Over $492,300|
|Married filing jointly||Up to $89,250||$89,251 – $553,850||Over $553,850|
|Married filing separately||Up to $44,625||$44,626 – $276,900||Over $276,900|
|Head of household||Up to $59,750||$59,751 – $523,050||Over $523,050|
Source: Internal Revenue Service
For example, if you’re filing as an individual, you can earn taxable income of up to $44,625 in 2023 and qualify for the 0 percent rate. Those with the married filing jointly status get double this amount, while married filing separately and head of household each have their own levels, too.
Earn up to this level in taxable income and you’ll enjoy that 0 percent rate on long-term gains. In fact, taking advantage of this special 0 percent rate is a key part of how you and your family could earn a six-figure income and pay no income tax at all on it.
You’ll need to have a strong grasp on your financial situation to take advantage of this low rate.
What to watch out for with the 0 percent capital gains rate
Those rules for claiming the 0 percent rate seem simple enough, but taxpayers need to be especially careful if they’re trying to do so. Here are some key issues to pay attention to:
- Stay below the income threshold. If you go over the income threshold for the 0 percent rate, you’ll be bumped to the 15 percent bracket and have to pay tax on any gains above the threshold at that higher rate or the even higher 20 percent rate – a costly mistake.
- It’s total taxable income, not your salary. You might think that you don’t qualify for the 0 percent rate because your stated salary is above the taxable income level. But the key level is total taxable income, which is adjusted gross income minus deductions. So you’ll be able to contribute to a retirement account – a 401(k) or IRA, for example – and reduce your taxable income, make other adjustments and then subtract your deduction before you arrive at taxable income. For example, a couple could make more than $100,000 in salary and still qualify once deductions and adjustments are factored in.
- Take advantage of tax-loss harvesting. To make sure you don’t exceed the income threshold, it can be valuable to realize any capital losses via tax-loss harvesting near the end of the year. Capital losses can offset capital gains, and you can deduct up to a net $3,000 in losses each year, helping keep your adjusted gross income in a good place. Tax-loss harvesting is a useful last-minute strategy, but be sure to avoid wash sales.
- Year-end distributions from mutual funds can foul up your plans. Mutual funds make distributions of capital gains and other cash at the end of the year, so this can be a last-minute wrench in your plans to claim a 0 percent tax rate, if you own any. That’s one reason among several that ETFs may be a better choice than mutual funds.
Stick to the rules for capital gains and you’ll be fine, but run afoul of them and you could end up paying a lot more than you anticipated.
Most American households can benefit from a 0 percent capital gains tax rate on their investments, but it’s important to follow the rules closely or you could wind up paying more than you expect. Still, it can be well worth your time and energy to understand the rules of the game so that you can take legal advantage of all the ways to build your wealth.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.