How to Pay 0% Capital Gains Tax

When you sell an investment for a gain outside of a retirement account, you typically pay “capital gains tax.” For example, if you bought an index fund for $10,000 and sold it for $15,000, you would have to report the $5,000 gain as income on your tax return. However, the tax rate applied to this income is completely different than the tax rate applied to earned income from your job.  

 There are only 3 main federal tax brackets for capital gains. You are either taxed at 20%, 15%, or even 0% (or a mixture of the 3).  Using the example above, if you were in the 20% tax bracket, you would pay $1,000 in federal taxes ($5,000 gain X 20%). (*additional NIIT tax may apply)

As you can see in the example above, a couple with taxable income of $65,000 would be taxed at 0% for any long-term capital gains until their taxable income reaches $80,000!  

This is where some tax planning can come into play. Depending on your financial situation, you might be unlikely to ever have taxable income low enough to qualify for 0% capital gains while you are working. But I have seen a number of instances where clients retiring early have opportunities to realize 0% gains.  

Consider a couple retiring at age 60, with $1,000,000 in IRAs and $1,000,000 in a non-retirement investment account. In the investment account, they have a stock worth $150,000 that they paid $50,000 for, which would result in a $100,000 gain when they sell it. They plan to draw down from the non-retirement investments only for the first 2 years of retirement and will have no other income. The only income to report on their taxes will be dividends and interest from their investments, which for this example, is $30,000/year.  

They could sell the stock with a $100,000 gain over two years, only realizing $50,000 in each year and never go over the $80,000 threshold, being taxed entirely at 0% on those gains at the federal level! 

Most retirees will not be able to do this in every year of retirement, but with careful planning, you might be able to create small pockets of years where you can realize gains at the best tax rate there is – 0%! 

Thank you for reading, 

 Alex 

This blog post is not advice. Please read disclaimers.