Capital Gains Rate

[patricles]

Hi everyone,

I have a question that's probably foolish but has me confused.  I know that long term capital gains rate is 15% if you are in the >25% and 0% if you are in the 10 or 15% brackets (I think dividends follow a similar rule?).  Where I'm confused is if an individual lives solely off capital gains, how does the income tax rate get calculated?  Say a single individual has no wages, interest income, dividends (hypothetical, I know) and lives by selling ~$40k of capital gains a year.  Do capital gains go towards figuring an individual's tax bracket, so this person would have $40k of income and be in the 25% bracket, and then the income would be taxed at 15%?

[tj]

Hi everyone,

I have a question that's probably foolish but has me confused.  I know that long term capital gains rate is 15% if you are in the >25% and 0% if you are in the 10 or 15% brackets (I think dividends follow a similar rule?).  Where I'm confused is if an individual lives solely off capital gains, how does the income tax rate get calculated?  Say a single individual has no wages, interest income, dividends (hypothetical, I know) and lives by selling ~$40k of capital gains a year.  Do capital gains go towards figuring an individual's tax bracket, so this person would have $40k of income and be in the 25% bracket, and then the income would be taxed at 15%?

Income less exemption/deductions = taxable income. If taxable income under $37.5k, 0% capital gains tax for fed, but you may have state tax. Furthermore if you are selling $40,000 of capital, it is highly unlikely that they would all be gains (vs invested capital)

[MDM]

Hi everyone,

I have a question that's probably foolish but has me confused.  I know that long term capital gains rate is 15% if you are in the >25% and 0% if you are in the 10 or 15% brackets (I think dividends follow a similar rule?).  Where I'm confused is if an individual lives solely off capital gains, how does the income tax rate get calculated?  Say a single individual has no wages, interest income, dividends (hypothetical, I know) and lives by selling ~$40k of capital gains a year.  Do capital gains go towards figuring an individual's tax bracket, so this person would have $40k of income and be in the 25% bracket, and then the income would be taxed at 15%?

Yes - with some qualification - to the bolded phrase.

See the Qualified Dividends and Long Term Capital Gains Worksheet in the Form 1040 Instructions, p. 43 here: http://www.irs.gov/pub/irs-pdf/i1040gi.pdf.

See also the Excel calculation for this in the case study spreadsheet.

[skyrefuge]

and lives by selling ~$40k of capital gains a year.

You may be aware of this, but I just want to clarify that selling $40k worth of an asset does not necessarily mean that are realizing $40k in capital gains. Often, your capital gains can be much lower, because some portion of that $40k may be the "capital" itself rather than the gains on that capital.

[patricles]

This is just a hypothetical situation to illustrate my question.  I'm not living off capital gains or will I be anytime soon, I'm still very much in the accumulation phase.  But I want to make sure I understand these calculations years in advance in order to make more informed choices.  Thanks for the feedback

[tj]

This is just a hypothetical situation to illustrate my question.  I'm not living off capital gains or will I be anytime soon, I'm still very much in the accumulation phase.  But I want to make sure I understand these calculations years in advance in order to make more informed choices.  Thanks for the feedback

To do an accurate calculation requires the knowledge of the proportion of capital which is originally invested vs the unrealized gain.

[AlexK]

If you play with this tax simulator for a few minutes it will all make sense. But I think for your situation it will be almost no tax due. The way tax brackets work is you are only taxed the higher 15% rste on the earnings which exceed the threshold for 15% tax rate.

http://www.bankrate.com/calculators/tax-planning/1040-form-tax-calculator.aspx

[DavidAnnArbor]

One end run around paying federal tax would be to have ordinary income up to the deduction and personal exemption amount, and then capital gains/qualified dividends make up the rest of the income up to the 15% tax bracket threshold. I assume the next dollar of capital gains after exceeding the 15% tax bracket would only be taxed at the 15% tax rate.

[patricles]

If you play with this tax simulator for a few minutes it will all make sense. But I think for your situation it will be almost no tax due. The way tax brackets work is you are only taxed the higher 15% rste on the earnings which exceed the threshold for 15% tax rate.

http://www.bankrate.com/calculators/tax-planning/1040-form-tax-calculator.aspx

Playing with that calculator did make a lot of sense, I appreciate the link AlexK