The Tax Relief Extension Reconciliation Act of 2005 was signed into law a couple months ago. Although I don't have the specific words of the bill, here's one magazine's paraphrasing: "Long term cap gains and dividend income for taxpayers in the 10% and 15% brackets are taxed at the max rate of 5% in 2006-7 and 0% (zero percent) in 2008." From another magazine, "In May, however, Congress passed the 2006 tax act, which extends the rate of zero percent beyond its scheduled expiration at the end of 2008, authorizing it to stay on the books through 2010."

My first thought was: "Cool. We can pay zero taxes after selling our $28 Tweedy, Browne shares that have the $15 cost basis."

My second thought was: "Hey, why not sell everything on 2 Jan 2008, buy it back on 3 Jan 2008, and enjoy a tax-free step-up in basis?"

My third thought is: "Ouch, what if everyone does this?!? There has to be a catch."

What's the catch?

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Co-author (with my daughter) of “Raising Your Money-Savvy Family For Next Generation Financial Independence.”
Author of the book written on E-R.org: "The Military Guide to Financial Independence and Retirement."
I don't spend much time here— please send a PM.

Catch is that you have to stay in the appropriate tax bracket.* Sell too much and suddenly you are in the 25% bracket.

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No more lawyer stuff, no more political stuff, so no more CYA

Another catch will be the possibility of AMT on your ordinary income.

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No more lawyer stuff, no more political stuff, so no more CYA

We seem to be able to stay in the 15% tax bracket, but long-term capital gains seem to cause us to pay AMT on our ordinary income.

HOWEVER if the only test is 15% tax bracket on ordinary income, doesn't that imply that you should get the lower cap gain rates? Or does the AMT somehow bring in higher cap gain rates?

This seems too TRICKY, I just don't begin to know how to figure it.

Audrey

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Retired since summer 1999.

cap gains + ordinary income must stay within the 15% brackets to retain the 0% taxation on LT cap gains.

What if everyone did this? My guess is that most folks in the 10% + 15% brackets don't have a ton of cap gains built up (they aren't investors). Second, anyone who sells will be buying back in the market shortly thereafter. As far as I know, there isn't any prohibition or negative tax consequence to selling and immediately buying back, just to force a recognition/realization of the gain.

Actually there might be negative consequences (but can be circumvented). Read about "wash sale".

My understanding of a wash sale is that it only prevents recognition of a capital loss when a purchase of a substantially similar security occurs within 30 days (before or after). It wouldn't prevent/complicate recognition of cap gains, right?

Right. Not a problem for gains.

Audrey

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Retired since summer 1999.

Martha,

You know to much. Please report for extermination tomorrow at 0600.

The Man

PS If you oversleep that's OK.

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The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane -- Marcus Aurelius

Martha can you provide a link on the exact wording 'cause I just had a CPA tell me that as long as I stayed under the earnings of the particular lowest rate, then I could cash in at 0% all of the LT cap gains. I had hoped that was true, as I do have a bunch of cap gains built up, with 0 cash basis, or nearly so. I had hoped to cash in and use the savings in taxes to live off for the year, and then commence the earnings (like pension, and short term cap gains). Is my CPA all wet?

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Mens ability to see the future is limited by their horizons of today!
Unknown!

The best source I can think of is Publication 17, which is the general publication on how to figure out your taxes. http://www.irs.gov/pub/irs-pdf/p17.pdf See table 16-1 and pages 105 and 106.

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No more lawyer stuff, no more political stuff, so no more CYA

Come on, ask me a computer question.

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No more lawyer stuff, no more political stuff, so no more CYA

What color is your computer?

(just trying to boost you up a bit)

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Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.

I hate AMT. *You still get taxed on your capital gains at the lower rate, but you expose more of your ordinary income to a higher tax. *Many deductions get eliminated as well. *

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No more lawyer stuff, no more political stuff, so no more CYA

Off black.

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No more lawyer stuff, no more political stuff, so no more CYA

See? You're a whiz!

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Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.

My wife recently told me "Wow look at those neat red computers Dell has now. I think we need one of those! It looks prettier than the blue one we have now." No wonder women get hoodwinked at the car lot and at the computer store.

I found two quotes at Fairmark.com, pasted in below:

Q. I'm concerned that a capital gain will push my other income into a higher tax bracket. Doesn't this mean the real cost of a capital gain is higher than it appears?
A: No, capital gain is "stacked" on top of your other income, so it won't push the other income up into a higher tax bracket. As we pointed out earlier, a capital gain increases your income, and that could cause you to lose a benefit somewhere. For example, your exemptions or itemized deductions might be reduced when you have a capital gain. So there can be some indirect tax costs when you have a capital gain. But your other income stays in the same bracket when you have a capital gain.

This one suggests that you could have higher gains, and get the zero% capgains treatment, as long as your regular income (interest and salary) stayed within the 15% bracket numbers.

But this one below says that capgains make it into your AGI, and count against you for other income-based phaseouts. Still, it says that the capgains portion of income would continue to get treated at its lower rate, which could include, presumably, the zero% rate.

Q: Does a capital gain increase my income?
A: There's a vague notion out there that capital gains aren't income because they're taxed at their own special rates. Folks are hoping, perhaps, that capital gains won't count when they determine whether they can deduct an IRA contribution, or how much of their social security benefit is taxable, or how much of their exemptions are phased out, among other things.
Unfortunately, capital gains are income. A special calculation provides the lower capital gains rate, but doesn't remove capital gains from your overall income (or adjusted gross income).

These came from the page on capgains questions at fairmark: http://fairmark.com/capgain/basic.htm


If all this is true, it has the strange 'cost' of making your cap loss carryforwards now worthless. It also suggests that there will be a huge amount of buying and selling of appreciated assets: houses, stocks come to mind, by retirees. Possibly even some people taking a year off from work in order to get low salaries and interest that year and then cash o ut whopping big capgains. Then again, maybe they would have been doing that already to get 5% gains under the current law. Am I missing something?

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ER for 10 years; living off 4.3% of savings (and a few book royalties ;-)

Bob, the examples aren't really on point.*It just says that when figuring brackets, ordinary income is counted first. Here is a thread I just found on the Fairmark Forum that discusses the issue and is consistent with what I said:

http://fairmark.com/forum/read.php?3,6552,6552#msg-6552

From a post by Kaye Thomas, a frequent poster and CPA:

In any event, the rule would apply only to the portion of gain that falls into the 10% or 15% bracket. For example, a single person earning $26,000 has only about $5,000 of unused 15% bracket before moving into the 25% bracket. If this person has a $30,000 capital gain, only $5,000 of that gain will be tax-free. This is gain that would have been taxed at 5%, so the savings are only $250.

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No more lawyer stuff, no more political stuff, so no more CYA

Five minutes with the actual form tells me this, which may be wrong...check it yourself.

You add your income and capital gains. Income is taxed from the regular income table. Gains under 29.7k single / 59.4k married filing joint is taxed at 5%. Gains over that are taxed at 15%.

So lets say you're married filing joint, you have 30k in income and 40k in capital gains. 30k is taxed at your ordinary income rate, the first 29.4k of gains is taxed at 5% and the rest at 15%.

Lots of other different options and whatnot (900 question form in the link martha provided under 'reporting gains'), especially for gains held 5 years or longer, but I think thats the gist of it.

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Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.