How To Use the 0% Tax Rate on Capital Gains

Dana Anspach is a Certified Financial Planner and an expert on investing and retirement planning. She is the founder and CEO of Sensible Money, a fee-only financial planning and investment firm.

The 0% long-term capital gains tax rate has been around since 2008, and it lets you take a few steps to realize tax-free earnings on your investments. Harvesting capital gains is the process of intentionally selling an investment in a year when any gain won't be taxed. This occurs in years when you're in the 0% capital gains tax bracket.

Key Takeaways

• The 0% capital gains tax rate can help you realize tax-free earnings on your investments in years when your income falls below a certain threshold.
• The taxable income thresholds for 2022 are $41,675 for single tax filers and $83,350 for married taxpayers filing jointly.
• If you qualify for the 0% capital gains rate, you may be able to sell your earnings tax-free and then buy the same stock back again with a higher cost basis for future gains.
• Tax gain harvesting is best done at the end of the calendar year, when you have a better idea of your income and any capital losses you might have.

How the 0% Rate Works

In tax year 2022, the 0% tax rate on capital gains applies to single tax filers with taxable incomes up to $41,675 and married taxpayers who file joint returns with taxable incomes up to $83,350.

There may be years when you'll have less taxable income than in others—maybe you're self-employed or are working part-time. You can also sometimes make a low-tax year occur on purpose in retirement by choosing which accounts to take withdrawals from each year.

Note

0% capital gains rates apply only to long-term capital gains, which apply to assets you've held for more than one year. If you hold assets for one year or less, your capital gains are taxed at your ordinary income tax rate.

Let’s say you’re married and your taxable income this year, calculated after subtracting your itemized deductions or standard deduction, is going to be about $60,000. You have about $23,360 of room ($83,350 minus $60,000) for more income before you hit the 15% long-term capital gains bracket.

You have a tax-planning opportunity if you own stocks or mutual funds in a non-retirement account and some of them have unrealized long-term gains. Let's say you have stock in Company A you bought for $20,000 several years ago and you were planning to hold it until it's worth $50,000. It's worth $40,000 now. You can sell it, realize the long-term capital gain of $20,000, and pay no taxes on the gain.

Then you could then turn around and immediately buy that same stock again for $40,000. This price becomes your cost basis for any future gains. When the value of your holdings hits $50,000, let's say in two years, you will only have $10,000 worth of gains to pay taxes on. Assuming you no longer qualify for the 0% capital gains rate, you will need to pay the 15% long-term capital gains rate on that gain, but it's a much smaller gain than it would have been if you hadn't harvest the $20,000 gain now.

Note

Before you re-buy the same stock that you just sold, make sure that every share was sold at a gain. Otherwise, the wash-sale rule could apply. A wash sale is when you sell a stock at a loss and then buy the same or a substantially identical security 30 days before or after the sale date. It's applicable to tax-loss harvesting, so you don't want to be selling securities for a loss and then trying to buy the same security immediately again.

How To Harvest Your Capital Gains

Unlike tax-loss harvesting, which can be done at any time of the year, you should wait until the end of the year to implement capital gains tax harvesting. That way, you'll have a better idea of what your total income and losses will be.

There are several other tips you should know as you consider reaping the benefits of your capital gains.

1. Find out if you will have any gains from mutual funds in your portfolio: Mutual funds distribute capital gains at the end of each year. The gains will likely be minimal if you own tax-managed funds or index funds, but funds that aren't managed with taxes in mind can generate large gains. You should find out what this gain will be before you intentionally realize additional gains.
2. Determine if you have any capital loss carryover: Check your tax return to see if you have a capital loss that's being carried forward from a previous year. Talk with a tax professional if you're not sure or can't tell. Past losses can carry forward indefinitely. They're first used to offset gains, then up to $3,000 of a capital loss can be used to offset ordinary income if you have no gains. Your gains will first use up all your old losses if you have capital losses that are being carried forward and you realize gains.
3. Make sure you have an accurate estimate of what your tax situation for the year: It's best to work with a tax professional or a financial advisor for these projections unless you're at least somewhat investment-savvy. You might also run multiple scenarios through online tax preparation software to help you do your planning.

Note

Years when you have capital losses may be a good time to capital gain harvest, since the losses could offset the gains you're realizing. At other times, you may want to reduce concentrated positions you have and use tax gain harvesting to rebalance your portfolio.

Benefits of Harvesting Gains for Retirees

Gain harvesting can be an effective way to realize tax-free gains, but you must build a habit of projecting taxes and looking for tax opportunities by the end of each year to make it work. You can reduce your tax bill during your retirement years by doing this consistently, which means more of your retirement income goes in your pocket.

Note

A miscalculation could be a costly mistake, so get help from a professional if you're at all unsure of your taxable income.

Frequently Asked Questions (FAQs)

Do capital gains count as income?

Capital gains will count toward your adjusted gross income for tax purposes. Capital gains income can bump you up into a higher tax bracket if you earn enough through investing and trading.

What is the capital gains tax rate on stocks held one year or less?

Short-term capital gains are taxed as ordinary income at your normal income tax bracket rate.