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Learn How You May Pay 0% In Capital Gains Taxes

November 17, 2020

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Twenty-Twenty has been a volatile ride to say the least. Some have come out with major wins in their investments and some have seen their profits of the last few years, slip right through their fingers. If your reading this its probably because you saw some profits though all this volatility and want to know how to reduce your tax liability, and nothing is better in the tax world the zero!

So how to get to 0%? First is to understand the basics of capital gains taxes. 1. There are two types of capital gains taxes; short-term and long-term capital gains taxes. Short-term capital gains are gains on assets held less than 1 year and are taxed like regular income, that means you pay the same tax rates you pay on federal income tax. Long-term capital gains are gains on assets held more than 1 year and they are taxed at lower rates. Both have the ability to be taxed at 0% if things line up properly for you. But what about when you don’t fall into the traditional 0% capital gains rates??? More about that later on….

For all-intents and purposes while it can be done to get your short-term capital gains taxes reduced to zero it does mean getting your adjusted gross income below the standard deduction, which for many people is difficult. In light of that, let’s focus on getting our long-term capital gains rates down. 

One simple way to achieve zero percent long-term gains rates is to simply get lucky and fall into the bracket naturally. If this is the case for you, great. If not let’s see if there are some things we can do to help get you there. Below is a chart of long-term tax rates. 

Option 1: Tax-loss Harvesting

Tax-loss harvesting is a strategic way to avoid paying capital gains taxes. It relies on the fact that money you lose on an investment can offset your capital gains on other investments. By selling unprofitable investments at a loss, you can offset the capital gains that you realized from selling the profitable ones. While this strategy can reduce your taxable income and may help get you into that 0% rate, this is a strategy that should be done with caution and attention to detail. Although, this may help justify selling a losing investment in order to get into a better option and get a tax benefit along the way. A discussion with a qualified advisor can help you determine if this strategy is right for you.


Option 2: Tax deductions

Utilizing the tax code, you may find yourself with the ability to take deductions beyond the standard deduction. This could in tern help reduce your overall taxable income, thereby reducing your capital gains tax rate. 


Options 3: Hold for the long term

While this doesn’t sound like it will benefit you immediately and get you to that 0% bracket it is a worth while discussion point. Let’s say that you have stock that you have held for a long time and you never plan on selling it but instead plan on leaving it to your heirs. Did you know when you pass, your heirs get a step up in basis? This means that the cost basis when they go to sell the investment is the cost basis on the day of your death. Any gains you experienced from the time you personally bought it until that point have essentially been washed away, leaving your heirs with a near 0% tax liability. That being said it is never a good idea to hold an investment beyond its useful lifetime just to save a few tax dollars. Opportunity cost could be a much higher price.

So what if none of this helps? What if you have done everything you can to reduce your taxable income and you still find yourself well outside the boundaries of the zero percent zone. Is there anything you can do?


Option 4: Advanced planning and opportunity zones

The Qualified Opportunity Zone Program (“QOZ Program”), created by the Tax Cuts and Jobs Act of 2017, is a tax-incentive program designed to encourage long-term private sector investments in designated communities known as Qualified Opportunity Zones by delivering certain tax benefits to investors through investment vehicles called Qualified Opportunity Funds. 


  • Qualified Opportunity Zones are designated census tracts throughout the United States that have been selected by state governors for inclusion in the program.
  • Qualified Opportunity Funds are investment vehicles that invest at least 90% of their assets in qualified businesses or real property located within these Qualified Opportunity Zones.
  • Taxpayers with capital gains from the sale of a prior investment may invest those gains within a 180-day period in a Qualified Opportunity Fund and achieve potential tax benefits. (Temporary extensions and exceptions for 2020 may apply)
  • Investments in Qualified Opportunity Funds are intended to help drive real estate development, job creation and overall economic growth in lower income communities.


QOZ’s help reduce your capital gains taxes in a few phases. 


Phase 1: Deferring capital gains – Any investment that has a realized capital gain can have the gain portion of the investment put in a QOZ fund. By putting the gain in a QOZ fund the taxes owed on that investment become deferred.


Phase 2: Reducing taxable gain – Any QOZ fund made before December 31st 2021 and held until December 31, 2026 will have the taxable capital gain amount reduced through a 10% step-up in basis.


Phase 3: Elimination of taxable gain – Any capital gains taxes on the appreciation of your investment in the Qualified Opportunity Fund if held at least 10 years will be eliminated.


In short here is a how the QOZ fund would work. Let’s say that you had XYZ stock that you have owned for the last 20 years and recently have considered liquidating it but you are afraid to sell it for fear of capital gains taxes. Let’s say that your cost basis is $100k but the present value is $500k. Traditionally if you sold it you would owe capital gains taxes on $400k and at a 20% tax rate Uncle Sam would get $80k. By placing the $400k in a QOZ fund the taxable amount on the $400k would be deferred into the future. If held for 5 years the taxable amount on the $400k would be reduced by 10%, effectively being taxed on only 90% of the gain. If held for 10 years in the QOZ fund the taxable amount would be eliminated. Assuming an average rate of return for this asset class of 7% your $400k in taxable gains would become $786,860 all tax free. 


Bottom Line: There are many ways to reduce your capital gains taxes but for some getting to 0% capital gains traditionally is not an option. For those individuals you may want to consider advanced planning techniques like the QOZ fund concept. For those of you on the border, a discussion with qualified advisor may help you use some of the techniques written about here today to reduce your overall tax liability.


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Let's talk about income sources. Which ones are the most tax efficient and as a bonus a few inefficient tax strategies just to be aware of. For the purpose of today's discussion we are not going to bring wages into play here. We are talking strictly about investment income sources. Income Source #1 ROTH IRA Income is the first and most obvious choice here. The benefit of the ROTH IRA if your not aware, (which is okay if your not - we are all about education here) is that you put your money in after you have already paid taxes but anything in the account grows tax free and can be taken out tax free in retirement. There are some nuances you have to be aware of like you must wait to take your distribution until you have had the account for 5 years you must be 59.5 years old but there are also some nuance early allowances like access to your principle portion at any time. But when it comes down to the general tax fee income it is really hard to beat the benefits of a ROTH IRA . 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Much like the ROTH IRA you put those dollars in after tax. Like a ROTH it grows tax deferred and the distributions can also be tax free just like a ROTH but that is where the similarities stop. Unlike a ROTH there are no contribution limits or age restrictions or holding requirements. Some types even protect your cash value from loss while others are directly invested in the stock market. From a tax perspective here is what makes this strategy so unique. We already talked about distributions being tax free but did you know when you borrow money from your life insurance as income the income you take could still earn interest??? Since it is being taken out as a loan against the account the money stays invested. If you earn an average return of say 7% but only pay 4-5% in interest you are actually making 2-3% a year on income you already took out of your account. How great is that. That is called positive arbitration. The best part is your income is tax free and when you die your beneficiaries also get the remaining balance tax free as well. Income Source #5 Social Security Income can be one of the most tax efficient sources of income in retirement. If you have ever attended one our classes on Social Security planning you may know some of this already but for those that haven't or need a recap lets dive in. Social security can be anywhere between 0% taxable all the way up to 85% taxable. But the unique thing is that social security is never 100% taxable. So at now point will 100% of your check count towards you adjusted gross income for tax purposes. How cool is that. Now how much if it that is taxed is based on provision income. If you missed last weeks video on that click HERE . But basically the lower we can get your provisional income the less taxes you pay on your Social Security which could end up being a big deal long term. These are some of the most tax efficient income sources and when planned for properly you could very well live your life free of the burden of the tax man . However, there are few sources that are not so tax efficient. Not so efficient income Sources IRA/401k Income - Yes you are reading this correctly because IRA dollars are pretax, they have never been taxed before meaning that it is very likely that 100% of that income source is taxed at your federal tax rate. Really the only way to get around this is to fall into the 0% tax bracket which may be hard for many Americans. But don't loose hope just yet. If you have IRAs/401ks talk to us about how advanced planning may help get you to that 0% or 12% rate even with an IRA/401k. Mutual Funds - One of the reasons mutual funds are so tax inefficient is because of internal turn over ratio and what I call phantom income tax. 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