First-time investors can make the mistake of focusing all their attention on the potential of the investment itself—whether that is real property, stocks, or something else entirely. However, without advance planning, taxes can subtract a large chunk of your profits. Savvy investors make decisions with the tax implications in mind, and use timing to their advantage to sidestep hefty tax bills.
One of the simplest ways to reduce your taxes and improve your profits is to work with a Certified Tax Planner. Another important step is to familiarize yourself with tax strategies for investors so you can begin to factor that into your investment plans. In this article, we will review one of the simplest timing strategies: leveraging the 0% capital gains tax rate.
How to Qualify for the 0% Tax Rate
To secure that 0% tax rate, the key is to set yourself up for success before selling your property or investment. Remember that until your investment is sold it is not considered taxable income. So until you have received a gain (or profit) on that sale, you still have an opportunity to reduce the tax impact.
The 0% tax rate only applies to long-term capital gains. From a tax perspective, a gain is considered long-term if you held the asset for more than one year before selling or otherwise disposing of it. So if you have owned, say, a certain amount of stock for 10 or 11 months, and you’re itching to get rid of it and move onto another investment, consider whether holding onto that stock for a full 12 months would qualify you for that 0% tax rate.
The other key factors are your filing status and taxable income. To qualify for the 0% tax rate, you need to fall within one of these thresholds (for assets sold in 2023):
- Single or Married Filing Separately: $0 – $44,625 in taxable income
- Head of Household: $0 – $59,750 in taxable income
- Married Filing Jointly: $0 – $89,250 in taxable income
Depending on your filing status and available deductions to lower your taxable income, that 0% tax rate can be fairly attainable.
The 0% long-term capital gains rate can also apply for business assets. If you are holding an asset as an investment through your pass-through business, when you sell that asset it is recorded as capital income and then reported on your personal tax return as the owner.
When to Factor the 0% Rate into Your Tax Plan
A number of different life circumstances could put you in a prime position to save money on your capital gains:
Younger Taxpayers. Taxpayers who began their careers more recently often have a lower income and can often benefit from the 0% rate. Now may be the time to begin buying and selling investments and taking advantage of those tax-free gains.
Reductions in Income. Taxpayers who are temporarily in a lower tax bracket should evaluate whether they can take advantage of a lower capital gains rate. This could apply to people who:
- have losses in their business
- sold their business and are on sabbatical
- are on family leave because they had a baby
- have just retired and are currently living on their savings
If you are in a similar scenario, now could be the time to lock in the power of that 0% rate. Remember that this is not a year-end “hack” that can be used at the last minute to secure tax savings. You will need to intentionally evaluate your finances early on to make use of this benefit.
High-Income Earners with Children. If you have investments with unrealized gains (meaning they are poised for a profit when they sell that investment), a common tax strategy is to gift the investment to their children to avoid immediate taxation. On the one hand, this can be a powerful strategy if you would normally be subject to the 3.8% net investment income tax or the 20% long-term capital gains rate. On the other hand, this strategy does not always result in a lower tax liability because of the “Kiddie Tax.” The IRS collects a levy on a child’s investment or other unearned income. This is where doing the actual math is key. If the “child” receiving the gift is either under age 18 or a full-time student under age 24, the gain will be taxed as follows:
- The first $1,150 in unearned income is tax-free
- The second $1,150 is taxed at the child’s marginal tax rate
- The remaining amount is taxed at the parent’s marginal tax rate
Depending on the total amount of gain and both parties’ tax rates that year, making a gift may or may not result in lower taxes. This is where working with a Certified Tax Planner can help you with weighing possible courses of action and selecting the one that will bring the most benefits.
Tax-free profits are the dream of any investor, and that dream can sometimes become a reality through the 0% capital gains tax rate. Timing and advance planning is essential for reducing your capital gains tax, as well as understanding how to qualify for tax-free gains. Before making plans to sell your investments, be sure to reach out to Certified Tax Planner to receive expert guidance on how to secure the lowest possible tax rate.