New to Harvesting Capital Gains

[PVkcin]

I have never harvested any capital gains before but have been researching this trying to wrap my head around it since our income is relatively low and we have shares of VTSAX sitting in a taxable account from years ago, as part of our future FIRE portfolio.  I just want to see if I am missing something.

We file taxes married filing jointly. Our 2018 projected AGI should be about $60,000.
Since we can make up to $77,400 and still stay in the 12% tax bracket (12% bracket means we pay 0 on Long Term Capital Gains), that means we could harvest up to $17,400 in gains and pay 0 federal tax? (We are in Nebraska so I believe we would still owe state taxes on the gains, and the little research I’ve done shows it would be taxed in Nebraska like regular w2 income).

Questions:
- As an example, would I just sell 50k VTSAX (bought for 32,600 as a cost basis, for example), and then could immediately buy a S&P500 index fund back the same day (50k worth)?  (although my cost basis would be more complicated since I bought in over a couple years every 2 weeks (dollar cost averaged) from my paychecks.)

-if we accidentally make more money this year than planned, and say our AGI ends up being $77,600 so we are in the 15% tax bracket, would the full $17,400 in gains then be taxed (even though we barely went over into the next tax bracket), and would owe 15% on the total gains so we’d owe $2610 in federal taxes? (.15 * 17400).

-Is there any reason not to harvest LTCG in our case, having a relatively low income? The only one I can see is that we would owe state taxes, which I would have to research how much we’d end up owing on that $17,400 gain.

[Davnasty]

I have never harvesting any capital gains before but have been researching this trying to wrap my head around it since our income is relatively low and we have shares of VTSAX sitting in a taxable account from years ago, as part of our future FIRE portfolio.  I just want to see if I am missing something.

We file taxes married filing jointly. Our 2018 projected AGI should be about $60,000.
Since we can make up to $77,400 and still stay in the 12% tax bracket (12% bracket means we pay 0 on Long Term Capital Gains), that means we could harvest up to $17,400 in gains and pay 0 federal tax? (We are in Nebraska so I believe we would still owe state taxes on the gains, and the little research I’ve done shows it would be taxed in Nebraska like regular w2 income).

This is something I'm interested in learning more about too, but I think I can answer a few of your questions.

Questions:
- As an example, would I just sell 50k VTSAX (bought for 32,600 as a cost basis, for example), and then could immediately buy a S&P500 index fund back the same day (50k worth)?  (although my cost basis would be more complicated since I bought in over a couple years every 2 weeks (dollar cost averaged) from my paychecks.)

You can buy the same fund back, there is no wash sale for capital gains, only capital losses.

-if we accidentally make more money this year than planned, and say our AGI ends up being $77,600 so we are in the 15% tax bracket, would the full $17,400 in gains then be taxed (even though we barely went over into the next tax bracket), and would owe 15% on the total gains so we’d owe $2610 in federal taxes? (.15 * 17400).

You would only be taxed 15% for the portion that goes over.

-Is there any reason not to harvest LTCG in our case, having a relatively low income? The only one I can see is that we would owe state taxes, which I would have to research how much we’d end up owing on that $17,400 gain.

Hopefully someone else has a better answer for this but I think it depends on what your long term plans are and whether you think current capital gains tax laws are going to change. For example, if cap gains taxes increase in the future then you may be better off harvesting now but if they don't and you move to a state with lower income taxes, it may be better to wait.

[terran]

I have never harvesting any capital gains before but have been researching this trying to wrap my head around it since our income is relatively low and we have shares of VTSAX sitting in a taxable account from years ago, as part of our future FIRE portfolio.  I just want to see if I am missing something.

We file taxes married filing jointly. Our 2018 projected AGI should be about $60,000.
Since we can make up to $77,400 and still stay in the 12% tax bracket (12% bracket means we pay 0 on Long Term Capital Gains), that means we could harvest up to $17,400 in gains and pay 0 federal tax? (We are in Nebraska so I believe we would still owe state taxes on the gains, and the little research I’ve done shows it would be taxed in Nebraska like regular w2 income).

It's actually better than that. You would subtract your deductions from your AGI to arrive at taxable income. Taxable income is what all the tax brackets (including the long term capital gains tax brackets) are based on. If you're married the standard deduction is $24k.

Questions:
- As an example, would I just sell 50k VTSAX (bought for 32,600 as a cost basis, for example), and then could immediately buy a S&P500 index fund back the same day (50k worth)?  (although my cost basis would be more complicated since I bought in over a couple years every 2 weeks (dollar cost averaged) from my paychecks.)

To elaborate on what @Dabnasty says, you're on the right track that capital LOSS harvesting requires to reinvest in something that is not substantially identical, but capital GAINS harvesting has no such rule. Feel free to reinvest in the same thing you sold.

-if we accidentally make more money this year than planned, and say our AGI ends up being $77,600 so we are in the 15% tax bracket, would the full $17,400 in gains then be taxed (even though we barely went over into the next tax bracket), and would owe 15% on the total gains so we’d owe $2610 in federal taxes? (.15 * 17400).

As @Dabnasty says, only the amount that goes over the 0% long term capital gains bracket is taxed at 15%. It's like other tax brackets where it's not a cliff, but rather only the amount in the bracket is taxed at the higher rate.

You might consider capital gains harvesting at the end of the year when you have a good sense of your earned income and after dividends are declared (usually mid December) so you'll know how much dividend income you'll have.

If you currently contribute to Roth IRA accounts you could consider recharacterizing some of your contribution after you know all other income such that you stay below the limits.

-Is there any reason not to harvest LTCG in our case, having a relatively low income? The only one I can see is that we would owe state taxes, which I would have to research how much we’d end up owing on that $17,400 gain.

As long as you're comfortable with paying the state tax, then I say go for it. If you plan to move to a no tax state in the future you might consider waiting, but otherwise you'll pay state tax one way or another.

Capital gains do increase AGI for things like healthcare subsidies if you're on ACA health insurance, so keep that in mind if that's your situation.

[MDM]

If you have money in traditional IRAs, it may be better to convert enough of those to Roth to fill the 12% bracket instead of the capital gains approach.

See the '0% LTCG or t->R' tab in the case study spreadsheet to do some "what if...?"s.

[PVkcin]

Thanks everyone for your thoughtful responses. This gives me a lot to think about, and I'll probably wait until December to actually execute the plan until I have a better idea of our income and dividends.

The one thing I am still having trouble wrapping my head around is exactly how much I can harvest:

@terran you said:

It's actually better than that. You would subtract your deductions from your AGI to arrive at taxable income. Taxable income is what all the tax brackets (including the long term capital gains tax brackets) are based on. If you're married the standard deduction is $24k.

I read towards the bottom of this article http://www.finra.org/investors/highlights/capital-gains-explained
"While capital gains may be taxed at a different rate, they are still included in your adjusted gross income, or AGI, and thus can affect your tax bracket."

So if I harvest more than $17,400, if it's added back into my AGI, doesn't that put me into the next tax bracket? I understand taxable income is AGI minus deductions (our standard deduction would be $24k like you said). But are you sure that I can use the taxable income amount to harvest gains, if the gains I harvest are going to be added back into our AGI and therefore put us over the $77,400 (12% tax bracket)?

There are so many steps, I keep getting lost in the details and can't keep this all straight.

[terran]

But are you sure that I can use the taxable income amount to harvest gains, if the gains I harvest are going to be added back into our AGI and therefore put us over the $77,400 (12% tax bracket)?

It's always best to go back to the source. Here are the draft instructions for the 2018 form 1040. Try putting some numbers into the "Qualified Dividends and Capital Gain Tax Worksheet" on page 40 (41 according to the PDF reader because of the draft warning on the first page which isn't part of the document page numbering) and see what you get. As you work through the worksheet you'll find that it will refer you specific lines of other forms and schedules, so just google "2018 form 1040," or "2018 schedule D," etc to find the drafts of those to see what it's asking for. You probably won't need to actually fill out those other forms and schedules as you'll be making numbers up, so just find what it's talking about and fill it out and you should have a very good understanding of how your taxes are computed.

Report back with what you learn, and let us know if you have any questions.

[PVkcin]

Thank you very much. I'll take a look at the 1040 form for 2018 and see what I come up with.

Related question:

Can you harvest capital gains inside of a traditional IRA? In a tIRA we haven't paid any taxes yet, and we will pay it when we withdraw the money. So I can essentially sell old shares and immediately by them back, to reset the cost basis to a higher cost now, therefore paying less taxes in the end when we withdraw the money? Am I missing something with this line of reasoning?

[terran]

Can you harvest capital gains inside of a traditional IRA? In a tIRA we haven't paid any taxes yet, and we will pay it when we withdraw the money. So I can essentially sell old shares and immediately by them back, to reset the cost basis to a higher cost now, therefore paying less taxes in the end when we withdraw the money? Am I missing something with this line of reasoning?

Nope, taxable only. You'll pay taxes on the total amount you withdraw, so capital gains don't play a role.

[Babybalrog]

-Is there any reason not to harvest LTCG in our case, having a relatively low income? The only one I can see is that we would owe state taxes, which I would have to research how much we’d end up owing on that $17,400 gain.

Only thing i can think of that others haven't mentioned is that your new shares (not any unsold) would be short term investments if you decide to you need to cash out within the next twelve months. Not a big deal since the new basis means you won't have much gains, and you can sale other shares.

[PVkcin]

Update:

@terran  I went to the 1040 worksheet like you suggested. Thanks so much to you (and all the other posters) - you are correct, it's even better than I thought. I thought I had to use the AGI number, but like you said, I can use "taxable income." So I can harvest much more than the $17,400 I was using in this example.

Now that we're closer to the end of the year, it seems our taxable income will end up being around $40,000. I could potentially harvest over $37,000 in capital gains but my state taxes capital gains the same as regular income. I ran the numbers and it seems I would owe over $3,500 in state taxes for 2018 (assuming total taxable income of $77,000 (40k + 37k capital gains) if I were to harvest the max capital gains (I didn't run the numbers for any state deductions for tax credits I may have so my actual state taxes owed would probably be a little less than 3500).

After potentially owing $3k to the state in taxes, it makes me wonder if harvesting is worth it?

[terran]

After potentially owing $3k to the state in taxes, it makes me wonder if harvesting is worth it?

It depends on what your other options are. Do you plan to stay in your current state? If so, do the extra capital gains end up in a higher state bracket than normal, or is it your normal bracket, just more income being taxed in that bracket? Paying tax now vs later doesn't make much (any?) difference if it's at the same rate both now and later, but if the rates are different (different marginal brackets) then you would prefer to pay the lower rate by keeping your income below the higher bracket.