TAX NEWS - June 2010

Save tax by selling this year

Quirk in capital gains means quick transaction can save lots of money

Q: I have a question concerning your recent column about the zero percent tax rate on long-term capital gains. What advantage is there in selling for a long-term gain, then buying back the same security? Any gain would be reinvested at or near the sell price.


A: This reader and many others with a similar question were referring to a zero percent federal income tax rate for long-term capital gains available to many taxpayers.

This zero percent rate remains a surprisingly little known provision of the Jobs and Growth Tax Relief Reconciliation Act of 2003. That's probably because this provision didn't become effective until 2008. It's set to expire after Dec. 31, 2010, along with other so-called Bush tax cuts.

Until then, if you sell a security you've held more than a year at a gain, and your total taxable income for the year, including the gain from the sale, does not push you beyond the 15 percent tax bracket, there's no tax to pay on the gain.

Therefore, I suggested the strategy (which I have followed) of selling a security for a tax-free gain, then buying it back.

I thought the advantage would be obvious, but it clearly wasn't for many readers. So I'll elaborate.

Say you paid $10,000 to buy shares of a stock or mutual fund years ago, and the shares are worth $20,000 now. Your taxable income for 2010 is low enough that even if you sell the shares for a $10,000 gain, you won't go over the 15 percent tax bracket. For 2010, single taxpayers with taxable income up to $34,000 and joint filers with taxable income up to $68,000 — that's the majority of Americans — won't go over the 15 percent bracket.

You sell your shares for $20,000 and buy them back. With stock, you might incur commissions and other trading costs, such as the bid-ask spread (you might not get quite $20,000 from the sale, and when you buy back your shares, they might cost more than $20,000). Between the time you sell and
buy back, the price of the stock or fund might have gone up. Of course, it might also go down, which would be in your favor.

But even if the sell-and-buy-back transaction sets you back a few dollars, you will have permanently shielded your $10,000 gain from taxation. The point: Next time you sell, you will be taxed only on any increase in value above the $20,000 repurchase price, not the original $10,000.

I don't know what capital-gains taxes will be in the future, but they could well be higher. Even if Congress does nothing, rates in 2011 will automatically revert to what they were before 2003. That means a taxpayer in the 15 percent bracket will pay a 10 percent tax on long-term capital gains (or 8 percent for ''super long'' gains on securities held more than five years, said John W. Roth, senior tax analyst for tax publisher CCH, a Wolters Kluwer business). Even at 8 percent, that's an $800 tax on what could have been a tax-free
$10,000 capital gain in 2010.

In addition, the maximum capital gains tax rate (for taxpayers above the 15 percent bracket) would go back from the current 15 percent to 20 percent in 2011 (or 18 percent for super long-term gains).

That's another argument for selling and buying back now, because the longer you defer realizing gains, the higher those gains might grow, pushing you into a higher tax bracket.