Take Advantage of 0% Capital Gains Tax Rate in 2010

You may have a rare opportunity to sell capital assets tax free in 2010, but this opportunity ends on December 31, so start planning to take advantage of it now.

The Tax Increase Prevention and Reconciliation Act of 2005 included a three-year capital gains tax holiday for taxpayers in the 10% or 15% tax brackets. The 0% capital gains tax rate applies to assets held for more than a year, including mutual funds and stocks. It also applies to qualified dividends.

This is a great deal that may not soon (if ever) be available again. Therefore, start your tax planning now if you have mutual funds or stocks that you purchased at lower prices more than a year ago and want to sell tax free. Also, keep in mind that if you have a big gain in a stock that you would like to keep in your portfolio, this can be a unique opportunity to increase your cost basis. Just sell the stock to book the long-term capital gain (on which you'll pay no tax) and then repurchase the same stock. If you are able to sell and buy back at the same price, your only cost will be brokerage commissions on the sale and repurchase (use a discount broker and you may be able to do both trades for less than $20). The advantage to you will be an increase in your cost basis from your original purchase price to your new purchase price at the same time that you book a no-tax gain.

To determine whether you are likely to qualify for the 0% capital gains rate in 2010, consult with your tax advisor and/or do a little homework on your own. If you were in the 10% or 15% tax bracket in 2009, for example, and expect your income to be about the same in 2010, you may qualify for tax-free capital gains. For 2009, maximum taxable income for the 15% bracket was $33,950 if your filing status was single and $67,950 if your status was married filing jointly, and these amounts are likely to be about the same in 2010.

One catch when evaluating whether you can take advantage of the 0% capital gains tax rate is that the capital gains must be included in taxable income when determining your tax bracket. If, when included, capital gains boost your taxable income above the 15% tax bracket maximum, a portion of the gains will be taxed. For example, if you file jointly, have $65,000 of taxable income before capital gains, and book a $10,000 gain on stocks you have held for more than a year, a portion of your capital gain (approximately $7,000 of the gain based on the 2009 tax bracket parameters) won't qualify for the 0% rate.

If you have substantial long-term capital gains in stocks or mutual funds, not taking advantage of this capital gains tax break before it expires could be costly since tax rates on capital gains and dividends currently are scheduled to rise in 2011. Long-term capital gains rates will go to 10% to 20% (from a maximum of 15% currently), while taxes on dividends will increase to ordinary income rates (from a maximum of 15% today).

Sources:

William Perez, taxes.about.com, Capital Gains Tax Rates: Tax Rates for Short-Term and Long-Term Capital Gains

Sandra Block, www.usatoday.com, 2008 drop in capital gains rate won't be for everyone - USATODAY.com

www.phoenixwm.phl.com, Tax Rates on Dividends and Capital Gains