Author Topic: Long Term Capital Gains Question  (Read 1176 times)

Penn42

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Long Term Capital Gains Question
« on: May 13, 2018, 07:52:17 AM »
I'm looking up how LTCG's work this morning and one thing is unclear to me.  From what I'm reading someone filing as single your LTCG tax rate is 0% up to $38,600 of income.  Does net capital gains add to my wages for that figure or not.  E.g. if I had 35k in taxable income from wages and 6k in net capital gains would I be over the threshold or not?
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Re: Long Term Capital Gains Question
« Reply #1 on: May 13, 2018, 08:01:30 AM »
Yes, that has been my experience. Taxable income includes earned income from a job, cap gains, dividends, required minimum distributions, social security payouts... any money you receive is counted towards your taxable rate bracket.
« Last Edit: May 13, 2018, 08:03:24 AM by Frankies Girl »
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terran

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Re: Long Term Capital Gains Question
« Reply #2 on: May 13, 2018, 08:05:50 AM »
Another point it's unclear to me whether you understand from what you wrote is that capital gains are taxed in brackets (just like ordinary income), so it's not a cliff or threshold you pass. So in your example, $3600 of your capital gains would be taxed at 0% and the remaining $2400 would be taxed at 15%.

Penn42

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Re: Long Term Capital Gains Question
« Reply #3 on: May 13, 2018, 08:09:56 AM »
Perfect, thank you.  Everywhere I looked simply said 38600 of income but didn't specify what that was exactly. 

EDIT:. I hadn't even picked yet and Terran knocked it out the park!  Thanks!

Follow up: in my previous example my taxable income would be 41k.  Are the cap gains counted "last" so I'd pay 0% LTCG on the $3600 up to the $38600 threshold and then 15% on the remaining $2400?  Or is it after you cross the threshld all capital gains hit 15%?
« Last Edit: May 13, 2018, 08:11:51 AM by Penn42 »
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Penn42

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Re: Long Term Capital Gains Question
« Reply #4 on: May 13, 2018, 08:25:33 AM »
Another point it's unclear to me whether you understand from what you wrote is that capital gains are taxed in brackets (just like ordinary income), so it's not a cliff or threshold you pass. So in your example, $3600 of your capital gains would be taxed at 0% and the remaining $2400 would be taxed at 15%.

I don't this will ever be a situation I'm in, but too make sure I understand how mashing both sets of brackets together works:

If I had taxable income from wages of 38.6k, any LTCG would be taxed at 15% up to a number that's larger than I need to worry about right now.  Say I had 43.9k of LTCG, which would take my total taxable income to 82.5k, the very edge of the 22% income bracket.  It would follow that those LTCG would essentially make any other income from wages skip the 22% bracket and go straight to the 24%.  Is that right?
« Last Edit: May 13, 2018, 08:29:11 AM by Penn42 »
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terran

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Re: Long Term Capital Gains Question
« Reply #5 on: May 13, 2018, 08:40:56 AM »
Another point it's unclear to me whether you understand from what you wrote is that capital gains are taxed in brackets (just like ordinary income), so it's not a cliff or threshold you pass. So in your example, $3600 of your capital gains would be taxed at 0% and the remaining $2400 would be taxed at 15%.

I don't this will ever be a situation I'm in, but too make sure I understand how mashing both sets of brackets together works:

If I had taxable income from wages of 38.6k, any LTCG would be taxed at 15% up to a number that's larger than I need to worry about right now.  Say I had 43.9k of LTCG, which would take my total taxable income to 82.5k, the very edge of the 22% income bracket.  It would follow that those LTCG would essentially make any other income from wages skip the 22% bracket and go straight to the 24%.  Is that right?

No, ordinary income fills the brackets first and capital gains stacks on top of that. I think the order would be something like ordinary income (including earned, social security, IRA withdrawals, pensions, etc.), interest and non-qualified dividends, short term capitals gains, and finally qualified dividends and long term capital gains. Basically the things with the highest tax rates fill your income "bucket" first, followed by things with lower tax rates. It doesn't matter when the income was earned, only that it was earned within the same year.

jacoavluha

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MDM

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Re: Long Term Capital Gains Question
« Reply #7 on: May 13, 2018, 03:26:36 PM »
No, ordinary income fills the brackets first and capital gains stacks on top of that.
+1

Different analogies work better for different people; this is the one that works best for me.

I.e., there is a "hole in the ground" equal to your standard deduction.  Ordinary income filling that hole isn't taxed at all.  As your ordinary income increases "above ground", it is taxed based on the amount above ground (your "taxable income") using the Familiar Brackets and Rates.

Then, LTCGs and Qualified Dividends are stacked on top of the ordinary income, and taxed at the capital gains tax rates applicable to however high "off the ground" they are.

MustacheAndaHalf

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Re: Long Term Capital Gains Question
« Reply #8 on: May 19, 2018, 12:07:17 AM »
In case different perspectives help, your W-2 income is represented as you, the wage earner.  Capital gains are a "hat" that always sits on top.  First you fill the tax brackets with ordinary income, then you note that income and shift to the capital gains rates.

Which makes for the following odd situation which hopefully helps: if you earn $33k income and $10k in long-term capital gains (LTCG), your LTCG are taxed roughly half at 0% and half at 15%.  If you earn $5k more income, you also push $5k of LTCG gains into the higher bracket.  Viewed from this angle, you pay both 12% tax on the added $5k income, and 15% because $5k of LTCG got pushed into a higher tax rate.  Back to the "hat" metaphor, you grew $5k taller, and your hat got pushed $5k taller as well.

Rubic

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Re: Long Term Capital Gains Question
« Reply #9 on: May 19, 2018, 05:47:51 AM »

Penn42

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Re: Long Term Capital Gains Question
« Reply #10 on: May 24, 2018, 07:00:49 AM »
Next question: what previous share price is used as the bench mark for determining capitol gains?  Say I have bought 1k of VTSAX in a taxable account every month for the past 24 months.  The price of each share has risen each consecutive month.  Now in month 25 the first 12 contributions are considered LTCG's.  If I were to sell 1k of VTSAX, would the first shares I bought chronologically be considered the benchmark to determine my gains?  Or are the cheapest shares I've bought considered the benchmark?  As if in month 8 there was a big dip and I bought those shares for less than the ones in month 1?
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terran

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Re: Long Term Capital Gains Question
« Reply #11 on: May 24, 2018, 09:02:42 AM »
Next question: what previous share price is used as the bench mark for determining capitol gains?  Say I have bought 1k of VTSAX in a taxable account every month for the past 24 months.  The price of each share has risen each consecutive month.  Now in month 25 the first 12 contributions are considered LTCG's.  If I were to sell 1k of VTSAX, would the first shares I bought chronologically be considered the benchmark to determine my gains?  Or are the cheapest shares I've bought considered the benchmark?  As if in month 8 there was a big dip and I bought those shares for less than the ones in month 1?

I don't know what the default is at Vanguard, but you can change this to whatever method you want to use. You can usually do average cost basis, first in first out, last in first out, specific identification, and maybe others.

Specific identification lets you pick the particular shares you want to sell and that's the cost basis you will have, so it offers the most control, but will require the extra step of picking the shares you want to sell. That's the one I would do.

Penn42

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Re: Long Term Capital Gains Question
« Reply #12 on: May 24, 2018, 09:00:24 PM »
Next question: what previous share price is used as the bench mark for determining capitol gains?  Say I have bought 1k of VTSAX in a taxable account every month for the past 24 months.  The price of each share has risen each consecutive month.  Now in month 25 the first 12 contributions are considered LTCG's.  If I were to sell 1k of VTSAX, would the first shares I bought chronologically be considered the benchmark to determine my gains?  Or are the cheapest shares I've bought considered the benchmark?  As if in month 8 there was a big dip and I bought those shares for less than the ones in month 1?

I don't know what the default is at Vanguard, but you can change this to whatever method you want to use. You can usually do average cost basis, first in first out, last in first out, specific identification, and maybe others.

Specific identification lets you pick the particular shares you want to sell and that's the cost basis you will have, so it offers the most control, but will require the extra step of picking the shares you want to sell. That's the one I would do.

Perfect, thanks.  I'm not going to be in this position for a while, but I was wanting to know how it works.  I'm glad there are multiple ways you are allowed to do it.
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terran

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Re: Long Term Capital Gains Question
« Reply #13 on: May 24, 2018, 09:12:46 PM »
You'll need to put in a request to have them change your cost basis tracking method, which might take a few days, so don't plan on waiting until when you need to sell unless you don't expect it to be that imminent. I definitely wouldn't wait until the last minute at the end of the year if you're planning to wait until you have a full picture of what your income will look like.

modulus

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Re: Long Term Capital Gains Question
« Reply #14 on: May 25, 2018, 07:25:56 AM »
Does the standard deduction not apply to the threshold for when LTCG gains are taxed?  I.e., would LTCG only be taxed if total income (wages + dividends + interest income + LTCG) surpassed $49700 (38700 + 12000 standard deduction)?

terran

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Re: Long Term Capital Gains Question
« Reply #15 on: May 25, 2018, 08:31:24 AM »
Yes, the standard deduction (or itemized deductions) apply. Capital gains work just like regular income in that the bracket is based on taxable income, not gross income or Adjusted Gross Income.

MustacheAndaHalf

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Re: Long Term Capital Gains Question
« Reply #16 on: May 25, 2018, 08:40:48 AM »
If you earn $12,000 to $261,000 then you can think of the standard deduction as subtracting the first $12,000 of income/gains/etc.  If your income approaches certain "phase out" limits, your standard deduction starts to shrink below $12,000.  A high income can reduce your standard deduction.

If you make $40,000 in income and $8,000 in LTCG (while filing as "single"):

(I personally prefer to view the standard deduction as happening first):
$40,000 income - $12,000 standard deduction = $28,000 left
$28,000 income - $9,525 first (0%) bracket = $18,475 left
$18,475 income - $18,475 second (12%) bracket = $0 left (room for $10,700 more)

$8,000 LTCG - $8,000 first (0%) LTCG bracket = $0 left (room for $2,700 more)

So in this example, $18,475 would be taxed using the 12% bracket (or tax tables really, which probably round up to the nearest $50 and cause $2,220 in tax).


terran

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Re: Long Term Capital Gains Question
« Reply #17 on: May 25, 2018, 09:01:56 AM »
If you make $40,000 in income and $8,000 in LTCG (while filing as "single"):

(I personally prefer to view the standard deduction as happening first):
$40,000 income - $12,000 standard deduction = $28,000 left
$28,000 income - $9,525 first (0%) bracket = $18,475 left
$18,475 income - $18,475 second (12%) bracket = $0 left (room for $10,700 more)

$8,000 LTCG - $8,000 first (0%) LTCG bracket = $0 left (room for $2,700 more)

So in this example, $18,475 would be taxed using the 12% bracket (or tax tables really, which probably round up to the nearest $50 and cause $2,220 in tax).

The first $9,525 is taxed at 10% not 0%, so total tax under this scenario would be $3,169.50.

SunshineAZ

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Re: Long Term Capital Gains Question
« Reply #18 on: May 25, 2018, 11:14:19 AM »
Since we are on the subject, how do bonds fit in?  Are bond gains counted as ordinary income or something else?  I am wondering because most drawdown strategies tell you to live off of bonds, so is there a tax advantage with bonds?  How are bond sales taxed? 

MDM

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Re: Long Term Capital Gains Question
« Reply #19 on: May 25, 2018, 11:36:15 AM »
If you earn $12,000 to $261,000 then you can think of the standard deduction as subtracting the first $12,000 of income/gains/etc.  If your income approaches certain "phase out" limits, your standard deduction starts to shrink below $12,000.  A high income can reduce your standard deduction.
It used to be that way, but is not under the new tax law.  There is no phase-out of the standard deduction in 2018.

terran

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Re: Long Term Capital Gains Question
« Reply #20 on: May 25, 2018, 11:51:18 AM »
Since we are on the subject, how do bonds fit in?  Are bond gains counted as ordinary income or something else?  I am wondering because most drawdown strategies tell you to live off of bonds, so is there a tax advantage with bonds?  How are bond sales taxed?

Any gains (increase in value) of a bond fund would be taxed as capital gains, but that will be small. Most of the income from a bond is in the form of interest which taxed at the same rate as ordinary income. That's why it's usually recommended to keep bonds in tax advantaged accounts.

Some kinds of bonds don't have taxable interest (like US savings bonds aren't taxed at the federal level at the state level -- I had that backwards, thanks MDM ), but they usually offer lower interest, so may not make sense unless you're in a high bracket and don't have space in your tax advantaged accounts for the amount of bonds you want to hold.

As far as drawdown, assuming you have both taxable and tax advantaged accounts, I would sell and withdraw the amount of bonds you want to pay ordinary income tax on from tax deferrred, and if you need more to live off of sell stocks from taxable (remember to also account for these capital gains) and sell more bonds in tax advantaged, but rather than withdrawing this amount use it to buy back an amount of stock equal to what you sold in taxable. Since money is fungible (doesn't matter where you take it from) selling stocks in taxable and buying equal amounts of stocks in tax advantaged means you you still own the same amount of stocks.

Of course, if you're an early retiree you have the extra step of that wiithdrawal from tax deferred actually being a conversion to roth which then "seasons" for 5 years before you actually withdraw it to live off of. The idea is basically the same though.
« Last Edit: May 25, 2018, 11:57:56 AM by terran »

MDM

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Re: Long Term Capital Gains Question
« Reply #21 on: May 25, 2018, 11:52:32 AM »
Pretty much a recap of what terran said, but this was already written so....
Since we are on the subject, how do bonds fit in?  Are bond gains counted as ordinary income or something else?  How are bond sales taxed?
Interest from bonds is taxed as ordinary income, with the following exceptions:
- Federal treasury interest is not taxed by states
- Most municipal bond interest is not taxed by the feds, nor by the state in which the municipality is located (including state bonds).

You may be subject to capital gains if a bond is either purchase some time after issue, or sold prior to maturity. 

See Taxes on Bonds and Bond Funds - Fidelity for more.

Quote
I am wondering because most drawdown strategies tell you to live off of bonds, so is there a tax advantage with bonds?
Of what drawdown strategy do you speak? 

E.g., see Variable percentage withdrawal - Bogleheads.  There is nothing there suggesting one should live off bonds as a long term strategy, let alone the interest alone.

SunshineAZ

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Re: Long Term Capital Gains Question
« Reply #22 on: May 25, 2018, 12:26:28 PM »

Quote
I am wondering because most drawdown strategies tell you to live off of bonds, so is there a tax advantage with bonds?
Of what drawdown strategy do you speak? 

Thank you for the useful information. 

I was thinking along the lines of a bond tent strategy.  Maybe I am misunderstanding how those work? 


boarder42

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Re: Long Term Capital Gains Question
« Reply #23 on: May 25, 2018, 12:35:36 PM »

Quote
I am wondering because most drawdown strategies tell you to live off of bonds, so is there a tax advantage with bonds?
Of what drawdown strategy do you speak? 

Thank you for the useful information. 

I was thinking along the lines of a bond tent strategy.  Maybe I am misunderstanding how those work?

bonds have typically performed opposite to that of stocks making them a good balance to ride out rough times in the market and smooth out the extreme variablility of stocks.  in general once you drop below 80/20 though you start to actually hurt your chances of success in a long FIRE timeline due to the drag bonds create on a portfolio.  i personally never plan to hold more than 10% bonds in FIRE.  we'll see what AA i go with when i get there.  but currently stocks and bonds have both reached all time highs together so they arent always counter to one another.  a Local RE play is likely a much better choice to get diversity and length out of a portfolio assuming it meets the return requrements of a good rental.  Bond security is way over stated and often over utilized.

Also more recent analytics on historical outcomes have found that a reverse equity glide path starting with a high percentage of bonds and slowly gliding to 100% equities is much better at extending the safety of a portfolio due to the Sequence of Return Risk in the first 5 years. 
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MDM

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Re: Long Term Capital Gains Question
« Reply #24 on: May 25, 2018, 01:05:49 PM »

Quote
I am wondering because most drawdown strategies tell you to live off of bonds, so is there a tax advantage with bonds?
Of what drawdown strategy do you speak? 

Thank you for the useful information. 

I was thinking along the lines of a bond tent strategy.  Maybe I am misunderstanding how those work?
OK, now we're talking percentages instead of all bonds.  Even with a bond tent (unless one takes it to an extreme) there will be stocks which generate some dividends and can be sold for income.

In general, bonds do not provide a tax advantage because (with the exceptions noted earlier - which often come with a lower interest rate than one can get with corporate bonds) the bond interest is taxed as ordinary income, while qualified dividends and long term capital gains get more favorable tax treatment.

What bonds usually do provide is some protection against the large short term drops that are more prevalent with stocks.

SunshineAZ

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Re: Long Term Capital Gains Question
« Reply #25 on: May 25, 2018, 01:46:35 PM »
OK, now we're talking percentages instead of all bonds.  Even with a bond tent (unless one takes it to an extreme) there will be stocks which generate some dividends and can be sold for income.

In general, bonds do not provide a tax advantage because (with the exceptions noted earlier - which often come with a lower interest rate than one can get with corporate bonds) the bond interest is taxed as ordinary income, while qualified dividends and long term capital gains get more favorable tax treatment.

What bonds usually do provide is some protection against the large short term drops that are more prevalent with stocks.
[/quote]

Thank you for the information.  Unfortunately now I am even more confused about drawdown strategies.  I think I need to start my own thread or case study about our plans.  Something to work on this weekend.  :)

MustacheAndaHalf

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Re: Long Term Capital Gains Question
« Reply #26 on: June 03, 2018, 09:17:23 AM »
$28,000 income - $9,525 first (0%) bracket = $18,475 left
The first $9,525 is taxed at 10% not 0%, so total tax under this scenario would be $3,169.50.
Oops, thanks for the correction.