Generally, profits from selling assets such as securities and real estate held in taxable accounts are classed as long-term if the holding period was longer than one year. Tax rates on long-term capital gains are zero, 15, or 20 percent, depending on the seller’s income.
To most efficiently use of the zero percent rate, your taxable income (after all deductions) in 2019 must be no more than $39,375 for single filers and married individuals filing separately, $52,750 for heads of household, or $78,750 on a joint tax return. (Inflation adjustments may increase those numbers in the future).
Example one: Ryan and Ellie Ford have income more than $100,000 on their 2018 tax return, reporting $60,000 of taxable income. (That is after taking the standard deduction and deducting pre-tax contributions to retirement plans). The Fords expect to have similar income in 2019.
Suppose Ryan and Ellie sell $50,000 of shares in a U.S. stock fund, which they had bought several years ago for $35,000, generating a $15,000 long-term capital gain in a taxable account.
Assuming the Fords will have no other capital gains or losses in 2019, this gain is expected to bring their taxable income for the year from $60,000 up to $75,000. In this scenario, the Fords will owe zero percent income tax on their $15,000 long-term capital gain because their taxable income would be under the $78,750 threshold.
What would happen if the Fords misjudge and wind up 2019 with taxable income of $80,000, including their $15,000 long-term capital gain? Does this prevent them from using the zero percent capital gains tax rate?
No, the Fords will not have their gain completely taxed at 15 percent. If Ryan and Ellie have taxable income of $80,000 — $1,250 above the threshold — that $1,250 would be taxed at 15 percent ($187.50), the next capital gains rate, and the balance of their gain ($13,750) would be taxed at zero percent. So, this couple would owe only $187.50 on a $15,000 long-term gain, which they might consider a savvy move.
Income from stock dividends may be taxed at ordinary income tax rates of up to 37 percent this year. However, on some dividends (subsequently discussed), taxpayers may owe zero percent. Again, the cut-off points are the same as they are for zero percent long-term capital gains: taxable income under $39,375 for single filers, for example, and $78,750 on a joint tax return.
Example two: George Drake is retired, with $55,000 in annual income, including $10,000 of income from stocks and stock funds that he holds in taxable accounts. George itemizes deductions, and his taxable income is well under $40,000 each year. As a result, George owes zero percent tax on his dividend income this year.
Most dividends, including dividends passed through from stock funds, are qualified dividends that receive favorable tax treatment, although some conditions apply. Qualified dividends are taxed at the same rates as long-term capital gains, so if your income is too high for the zero percent rate, you will owe tax at 15 or 20 percent.
It is a truism, for good reason, that you should not let the tax tail wag the investment dog. That said, if you expect to be in the zero percent bracket, you might consider holding some dividend-paying stocks or stock funds in a taxable account for untaxed income.
Trusted advice: qualified dividends
Qualified dividends must pass all these tests:
- They must be paid by a U.S. corporation or a qualified foreign corporation.
- They must not be specifically excluded by the IRS as not eligible as qualified dividends (see IRS Publication 550, p. 20). That list includes capital gains distributions and payouts that are really interest income.
You must have held the stock paying the dividends for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. (The ex-dividend date is the first day of trading on which the buyer of a security is no longer entitled to the most recently announced dividend).