Tax Tips Blog

Jay writes:
Hello Gina! I’m married and I file jointly with my wife. Our taxable income is about $45,000. I believe this means I can have capital gains of about $20K without paying taxes on these gains this year or next (assuming my income stays the same for 2009, which I believe it will).

Is there any reason I can’t sell stock my stock that has a gain and then turn around and buy the same stock at the same time and still not pay any capital gains tax and have an increase in the basis with the new stock I purchased?

Thanks,
Jay

My reply:
For 2008, since you will be filing MFJ, if your taxable income falls between $16,050 and $65,100, you will be in the 15% tax bracket. For 2008 through 2010, capital gains and certain qualified dividends will be taxed at 0% for taxpayers in this tax bracket.

This 0% rate would apply to your adjusted net capital gains. Your adjusted net capital gains includes any qualified dividend income (the dividends that are not treated as investment income) and your net long-term capital gains less your net short-term capital losses, not including any gains from the sale of collectibles, qualified small business stock and depreciable real property.

Based on the information that you provided to me, I cannot think of any reason why your plan would not be allowed; however I would run a tax projection to make sure that your large capital gains do trigger Alternative Minimum Tax (AMT).

Best wishes,
Gina

Steve writes:
I’m sure this question has been covered, but I can’t seem to find the answer I’m looking for….

My spouse does not work. I participate in a 401K. Our modified AGI likely will be 160+. As far as I can tell, we cannot contribute to a Roth IRA. I can contribute fully to a traditional IRA, and to a spousal IRA, up to a combined total of 8K. But no portion of any contribution that I make to either is deductible. Am I right thus far?

With this in mind, does it make sense to contribute to traditional/spousal IRAs, even though contributions are not deductible?

Thanks,
Steve

My reply:
Hello Steve! I have written a lot about retirement plans, including using a non-deductible IRA, and if those posts didn’t help you, I hope this one will…

First, your thinking is correct. Now to try to help you decide if contributing to a non-deductible IRA is right for you, please consider the following:

If you decide to make the non-deductible IRA contribution then you’re free to invest in whatever you like (that’s allowable for an IRA, of course) and you won’t have to worry about current taxes. You can change from one investment to another without incurring capital gains taxes. And when you do eventually withdraw the money from the IRA, you will recover your contributions tax free, so there is no double taxation. The taxable portion of the withdrawals will be taxed as ordinary income. So this would be a good place to invest in things that generate ordinary income anyway, such as corporate bonds, REITs and stock trading on a short-term basis.

And, if the law doesn’t change between now and 2010, starting in 2010, you’ll be able to convert your traditional IRAs to Roth IRAs, notwithstanding your income. You’ll pay tax (at ordinary income rates) on the appreciation between now and the time of conversion, of course, but from then on all further appreciation will be tax-free. If you already had substantial assets in a low-basis IRA, it probably wouldn’t make sense to consider this route, but it sounds like this will be your first traditional IRA.

Or, instead of contributing to a non-deductible IRA you could save for retirement outside of a retirement account, in an after tax account. The goal would be to try and take advantage of the current low tax rates on long-term capital gains and qualified dividends. To accomplish this you could purchase stocks that pay qualified dividends and plan on holding the stocks for at least a year. If you were able to accomplish this, then the maximum tax rate on these items would be 15%; thus you’ve limited your tax exposure. Another option would be to invest in tax-free bonds. With the possible exception of AMT, you would not pay taxes on the tax free bonds. Investments in real estate would be another option. Real estate investments can generate current tax free cash flow and long term gains.

There really isn’t a right or wrong way to go - it’s up to you and your preferences.

Best wishes,
Gina

Anne writes:

Hello Gina,

I have some clients who may benefit from the new 0% capital gains starting in 2008. I have some clients that are sole proprietors, giving them some room to potentially get themselves into the required tax bracket needed to obtain this capital gain rate. So, my question arises from the “too good to be true” thought. Here is one example of my client situation. He has an LLC, which will more than likely show a loss, rental units that usually show a loss, reported on schedule E pg 1, and a Sch C which could show income, although they have purchased a fair amount of equipment that could be written off, due to the 50% bonus depreciation & S179 deductions. So, I think he could easily get his income down to a point that he falls into the 10-15% tax bracket. It seems too good to be true that he can take all this depreciation in order to get into the bracket, so I’m thinking there must be some rules that I’m not seeing. What are your thoughts?

My reply:

Hello Anne, it’s great to talk to another professional!

The main thing that I’d watch out for with the Long-Term Capital Gains (LTCG) rate is Alternative Minimum Tax (AMT). As you’re probably aware LTCGs can phase out the AMT exemption and personal exemptions triggering additional Federal tax liability. In addition, there may be issues with the state and local taxes. If your client will incur a large LTCG for state tax purposes they will most likely want to itemize their deductions on their Federal return. This may reduce their Federal liability, but state and local tax payments need to be added back when computing Alternative Minimum Taxable Income (AMTI); thus most of the value of the state and local tax is lost for AMT purposes. So when you run your tax projection for them don’t forget to calculate AMT.

Best wishes,

Gina

Rich asks: Just wanted to stop in here to get a clarification on my thinking regarding a recent stock transaction. Quite a few years ago, I had been holding stock in ZDNet (ZDZ) and that was acquired by CNet in October of 2000. For each share of ZDZ, I received 0.5932 shares of CNet stock. In 2007 I sold the CNet stock. If I am correct, I believe I would report the basis as the original purchase of ZDZ. As an example, consider the following: Bought 500 ZDZ @ $10.00 = $5000.00 Merger 500 ZDZ become 290 CNET Sold 290 CNET @ $5.00 = $1450.00 Transaction results in loss of $3550.00, is that correct? Or do I use the price from 10/17/2000 when my ZDZ became CNET stock? Thanks, Rich

My reply: I hate to be the one to tell you this, but the only person who can help you answer this question right now is the company involved in the transactions, namely CNet. They sent you paperwork back in 2000 which would explain how to compute your basis. If you no longer have that paperwork, you’ll have to call them, write them, do whatever it takes to get it from them.

There are seven different ways in the tax code to structure a corporate reorganization so that is it is for the most part tax-free at the time. Each method results in a slightly different tax result.

But corporations are not required to make their reorganizations tax-free. They could have used a taxable reorganization. The only way to know which method was used was to read the paperwork they sent you regarding the reorganization.

In short, this is why I inform my clients that they must keep up with their basis adjustments at the time of the split/merger/spinoff/dividend reinvestment, not years down the road when they sell it or gift it or it gets transfered through inheritance.

Best wishes,

Gina

Tim writes: Hello. I’ve now been investing and learning a little over 5 years. Somewhere I remember reading that if one holds stocks or funds for over five years the tax basis is even lower that the year and a day basis. I don’t remember where I read that but if you can enlighten me, I would appreciate it very much.

My reply: Oh Tim. There was a tax rule in 2001, known for a brief time as the “ultra or super long-term gains rate” that reduced the tax rate on those gains, but that rule didn’t last long enough to have any practical effect.  It’s just helping to confuse taxpayers and keep the tax code as long and confusing as possible.

The current rule, which began in 2003 is that all long-term capital gains are taxed at a reduced rate. You may wish to read this article I wrote about the capital gains rates last March. Then once you get that read, prepare yourself for another change….when I’m not sure, but it’ll happen.

Best wishes,

Gina

Steve asks:I am planning to sell shares of stock that I own which are currently subject to Long-Term Capital Gain treatment, as I have held them for over a year. I’m not clear on the following things: 1) How do I qualify for LTCG of 5%, i.e., is there an income limit? 2) Is there an even lower rate (0%??) if I hold on to the stock longer, and if so, how much longer? 3) Is there an income limit for the lowest rate?

My reply:To determine at what rate your capital gains will be taxed you must first compute your taxable income.

Your taxable income (which is your income after taking into consideration all exemptions, deductions and adjustments) determines what tax bracket you will be paying tax in.

Your tax bracket determines the Long Term Capital Gains (LTCG) rate.

The 5% rate on Long Term Capital Gains (LTCG) applies to the amount of LTCG that takes you to the top of the 15% tax bracket.

The calculation of the income limit uses the same method as the current, but the brackets, exemption and standard deduction amounts change annually due to inflation. The following table outlines the Capital Gains Rates for 2007 on the sale of stock:

In 2008, the 15% Long-term rates will remain the same, but the 5% long-term rates will drop to 0%.

Then in 2011, the capital gain rates will return to the old 20% and 10% rates, and the five-year holding period rules and rates.

These rates apply to both regular and AMT calculations. The capital gains rate for collectibles was not affected by this law change and has remained at 28%.

Recaptured section 1250 gains have stayed at 25%. Since the computation involves many calculations it is wise to have a qualified tax professional help you when you prepare your return.

Best wishes, Gina

Elizabeth purchased 500 shares of stock on November 18, 2005 for $5 per share, giving her a basis of $2,500. The stock is now trading at $30 per share (potential selling price of $15,000). Elizabeth wants to realize her profit because she’s afraid it will decline in value, but she is concerned about her taxes because selling before November 18th will result in a short-term capital gain and Elizabeth is in the 33% tax bracket. Elizabeth can use the following formula to determine what price is the “break-even price” or the price at which selling the stock as a short-term capital gain at 33% tax rate would equal the same net amount of cash as if she sold the stock as a long-term capital gain at 15% tax rate: Breakeven point = (Current Price - [(Current price - basis) X ordinary tax rate] - .15(basis)/.85) Putting Elizabeth’s numbers into this equation we have: Breakeven point = ($30 - {($30-$5)X .33] - .15($5)/.85) Elizabeth’s breakeven point = $26.47 If Elizabeth were to sell her stock at its current price, her after-tax proceeds would be $10,875. If the price of her stock were to fall to $24.71 after November 18th, her after-tax proceeds would be $10,875. Thus, if Elizabeth believes that her stock price will not fall below $24.71 per share between now and November 19, 2006 should would net more after-tax money by holding her stock until at least November 19, 2006 when her sale would be treated as a long-term capital gain.

A retiree asks: I was told by my financial advisor that I can sell capital gain assets in 2008 and not have to pay any taxes. Is this true? My answer:I’m glad you are skeptical of advise given to you by a non-tax professional, as your financial advisor is not telling you the complete tax story. However, you might be able to accomplish that goal, but probably not. You haven’t provided enough information for me to make an accurate guess (and I could only make a guess at this point since the tax laws may change between now and 2008). I’ll apply a few assumptions so you can see how this might work. I’ll assume married and you file jointly. Most retirees have Social Security income, so I will assume you do too, in the tune of $20,000. I’ll also assume you have interest and divided income of $12,000 and tax exempt income of $8,000. Since your interest plus dividends plus tax exempt income plus half of your social security is less than $32,000 you currently do not have to pay tax on your social security income. Using the standard deduction, your taxable income would be $2,000 putting you in the 10% tax bracket. Now I’ll also assume that you have appreciated stock that you plan on selling in 2008 for a gain of $40,000. Your income for computing how much of your social security benefits are taxable just increased making 85% of your previously untaxed social security income taxable. This is $17,000 of additional taxable income, bringing your taxable income to $19,000. Will you owe capital gains tax on the $40,000 gain in 2008? No, because you’re in the 15% tax bracket, making your capital gains rate still 0%. But since your taxable income increased you will have an additional taxes of approximately $2,273. If you itemized your deductions, specifically medical expenses, instead of taking the standard deduction this increase in taxable income may limit those deductions as well. So, you’re not paying NO tax, but you’re paying less than you if your gains were taxable.

Jane is in the 33% tax bracket for 2006. Her income includes $2,000 of interest income and $6,500 of net long-term capital gain from sale of gold. She also has $5,000 of investment interest expense from broker margin accounts. She expects her 2007 income and deductions to be similar to 2006. Generally, investment interest is only deductible, as an itemized deduction, to the extent of investment income. If Jane were to prepare her return without considering her available options, she would probably just deduct $2,000 of her 2006 investment interest expense and carryforward the remaining $3,000 indefinitely. Many taxpayers are surprised to hear that Gold is considered a “collectible” and is subject to the 28% capital gains rate, not the more common 15% long-term capital gains rate. Because of this, Jane would be better off if she made an election on her 2006 tax return to include part of her net capital gains in investment income. Making this election would cause Jane to treat $3,000 of the net capital gain as investment income. In doing so, this $3,000 is taxed as ordinary income at her 33% tax rate instead of at the 28% collectibles long-term capital gains rate. This results in an addintal $150 [$3,000 X (33% - 28%)] of tax paid on the net capital gain, but she is now entitled to an additional $3,000 of investment interest expense deduction. This results in a tax savings of $990 ($3,000 X 33%). The net result is a tax savings of $840! This election should not be made without first considering your entire tax situation and expected future tax situation. If the gain was instead taxed at the 15% capital gains rate or if Jane expected her 2007 investment income to increase or if she expected her 2007 taxable income to increase enough to push her into a higher tax bracket, this deduction may not be as beneficial. There are other issues that may also need to be considered, such as whether there are any other capital gains before making a decision such as this. As always, it is best to consult with your tax advisor in situations such as this.

Jim needed some cash so he was thinking of selling one of his stocks. He purchased this stock on November 15, 2006 for $1,000, but as of the time he called it was only worth $400. He thinks the stock will come back around, but he needs the cash before the end of the year and wanted to know what the tax consequences of selling would be. Jim is in the 35% tax bracket and he already sold stock this year and has a short-term capital gain of $1,000 and a long-term capital gain of $2,000. He’s not anticipating any more sells this year. I told Jim that if the price of the stock would stay the same between now and November 15th (which I doubt), and he sold it then he would recognize a short-term capital loss of $600. The loss would offset his current short-term capital gains of $1,000, creating a $210 tax savings ($600 X 35%). If Jim instead waits and sells his stock after November 15th, but before the end of the year, and the price stays the same as it is now, he will recognize a long-term capital loss of $600. This loss will offset his $2,000 capital losses, creating a tax savings of $90 ($600 X 15% long-term capital gains rates). By selling the stock before November 15th he will generate a short-term capital loss, which will save him an additional $120 in taxes because of the difference in the short-term and long-term capital gains rates. My friend, William Perez, has an excellent article on his website regarding how to calculate capital gains that I recommend everyone to read.