Taking Advantage of 0% Capital Gain Tax in 2008?

A Jan 17, 2007 article in the Wall Street Journal states the following regarding people in the bottom two tax brackets: "If you still have confidence in your investment, but you
want to take advantage of the zero rate next year, here's a strategy to consider: Sell some of the investment at a gain in 2008, and then immediately buy back shares of the same investment. That means you can still enjoy that zero rate, maintain your position in the security but have a higher basis when you eventually sell the new shares. (The strategy doesn't run afoul of so-called wash-sale rules, because these only apply when selling an investment at a loss, not for gains.)" Question 1: Will the sale of stocks in 2008 and the associated capital gains throw you into a higher tax bracket. For example, if taxable income in 2008 is $60,000 and capital gains are $35,000, does this throw you into a higher tax bracket and therefore the 0% tax on capital gain would not apply? Question 2: I have about $250,000 capital gain in my house (after the $500,000 exclusion). If I sell my house in 2008, do I pay any capital gain tax? If no tax, can I sell the house to my wife and get the favorable tax treatment? << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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Long-term capital gains have two rates: 5% (0% in 2008) and 15%. The 5/0% rate only applies to that gain which would fall into the 15% ordinary income bracket if the gain were ordinary income. Using the 2007 brackets for the example (since we don't know what the 2008 brackets will be), we see that for MFJ, the top of the 15% bracket is at $63,700 of taxable income. So if you had $60,000 of taxable income (not counting the long-term gain) and $35,000 of long-term gain, then the first $3,700 of the gain would be taxed at 0% and the remaining $31,300 at 15%.

Yes. See above.
-- Rich Carreiro snipped-for-privacy@animato.arlington.ma.us
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or less. Not exactly a tax break for middle class or better who would have investment or deferred income substantially greater than that. Might work for a modest retiree who is sitting on stock for a long time that may be mostly gains and wants to tke it w/o taxes. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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Unfortunately the article doesn't really clearly explain how the 0% rate applies. The gist of the article appears to be that a person with significant non-capital gains income can indirectly take advantage of the 0% rate by transferring (by gift) appreciated property to persons who will have little or no taxable income of any sort for '08, e.g., one's college-age or younger children. By doing so, and depending on your gift-tax exposure, the child would sell some of the appreciated property in '08 and take advantage of the 0% rate, effectively permitting the parent to transfer a greater sum to the child than the parent could have done if they had transferred money that had already been taxed. In other words, if you're going to have to pay for your child's education anyway, instead of paying the tuition directly using money that you've already paid, say, a 30% income tax on, transfer appreciated property with a value of $12k or less to the child (thereby avoiding gift tax on the value of the property) and have the child sell the property and use the proceeds to pay the tuition. Since most parents are unlikely to get much benefit out of paying tuition costs directly because of the phase-out of the education credits, in the scenario described, it would make more sense to transfer the appreciated property to the child and let them pay the tuition themselves. Provided that the child's total taxable income, including any gain from selling the appreciated property, was less than about $33,900 for '08, the gain on sale of the property would be taxed at the 0% rate. Of course, this only makes sense if the property is substantially appreciated, since the basis in the property is the parent's cost as measured in after-tax dollars invested in the property - thus, the basis represents money already taxed. For example, suppose Parents, who file joint, will have $90,000 of wage income for '08, and will therefore not qualify for the 0% rate. Suppose also that they intend to sell stock with a value of $12,000 to pay for child's tuition in '08, and that child has her own taxable income of $10,000 from wages. If the basis in the stock is $1,000, then gain from the sale will be $11,000. If Parents sell the stock, they will pay tax of $1,650 on the sale, leaving them with net cash of $10,350 ($12,000 proceeds, less $1,650 tax) to spend on child's tuition. On the other hand, if Parents make a gift of the stock to child, and child sells the stock for $12k, then child will also recognize $11k of gain (basis transfers in this case), will have total taxable income of $21,000, thereby qualifying for the 0% rate on all of the gain, and will pay a tax of $0. As a result, child will have net cash of $12,000 ($12,000 proceeds, less $0 tax) to pay her own tuition. In addition, child is likely to qualify for one of the education credits, resulting in even less tax due on her other wage income. Assuming that child qualifies for a $1,000 education credit as a result of paying her own tuition (which should be fully useable with other taxable wage income of $10,000), the net effect of Parents transferring the stock to child instead of selling it and paying the tuition themselves could be as great as $2,650; i.e., child receives $2,650 more in economic benefit - money to spend - than if Parents had sold the stock themselves. That's a nice present from Uncle Sugar. In particular, it should be noted (the article you refer to does not highlight this point) that the amount of capital gain that qualifies for the 0% rate is the amount of gain you have that, as a general rule of thumb, does not exceed $33,900 minus the amount of your non-long-term-capital gain income ($67,800 minus non-cap gain income if filing jointly). In other words, if your non-long-term-capital gain income exceeds the threshhold at which the 25% rate bracket applies (approximately $33,900 or $66,800 for single/joint, respectively, for '08), then none of your capital gains will qualify for the 0% rate and will, instead, be taxed at the by-now-normal 15% rate. So, to answer your questions:
Q1: No, the amount of capital gains will not, by itself, disqualify you for the 0% rate; however, the amount of gain that qualifies will decrease as your other income increases, and none will qualify if your other income exceeds the bottom of the 25% rate bracket. Thus, given your facts, if you file single, your other income exceeds the cap for '08 of approximately $33,900, and none of your cap gains will qualify; if you file joint, your other income is below the cap of approx. $67,800, but only about $7,800 of your cap gains will qualify for the 0% rate, the remainder ($27,200 $35k - $7,800) will be taxed at the 15% rate. Q2: First, you cannot sell your house to your wife and recognize either gain or loss, see Code Section 1041(a). Sec. 1041 is mandatory and prevents gain recognition even on arms' length sales between spouses. See,e.g., Temp. Treas. Reg. 1.1041-1T(a), A-2. Instead, the transfer would be treated as a gift from you to your wife, and any consideration she paid you would be treated as a gift from her to you. As a result, regardless of your other income, selling your house to your wife would not permit you to recognize any of the unrealized appreciation in your house, or to take advantage of the 0% rate. If you were to sell your house to a third party, however, assuming that you and your wife had no other income for '08, and that you file jointly, only about $67,800 of the gain in excess of $500,000 would qualify for the 0% rate. The remaining $182,200 of that gain would be taxed at the 15% rate. To the extent that you have other income, that other income would reduce the amount of such gain that would qualify for the 0% rate and, once your other income exceeds $67,800, none of your gain in excess of $500,000 would qualify for the 0% rate. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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Wouldn't the fact that the child used the money from the sale of the gifted stock to pay his tuition cause him to lose his eligibility as a dependent? To claim the child as a dependent, the parent would need to pay at least half of his support. The parent is probably not paying much of anything to support the child away at college other than his tuition and room and board. If the child pays his own tuition, wouldn't this jeopardize his standing as a dependent? The money saved by having the child sell the appreciated stock with zero capital gain might be outweighed by the loss of the dependent deduction. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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njoracle wrote:

Q1. Using your example of $60K before capital gains and $95K after gains and assuming this is a joint return and that in 2008, the 15% tax bracket ends at $65K you would get the following result: $5K taxed at zero percent and $30K taxed at 15%. The reason for this is that your ordinary taxable income of $60K is $5K below the $65,000 limit of the 15% tax bracket. Q2. If you sell your house with a $750K realized gain you will pay tax on your recognizable gain. How much gets taxed at 0% and how much gets taxed at 15% depends upon your ordinary taxable income. See above. -- Alan http://taxtopics.net
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A.G. Kalman wrote:

===snipped== Thanks for all the great answers to my question from everyone in this NG. Being retired, my income is fairly predictable. Therefore, in 2008 I'll just sell enough to still keep me in the 0% capital gain bracket. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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njoracle wrote:

Not to contradict anything anyone else contributed, but it's useful to remember that taxable income reflects adjustments and standard/itemized deductions and exemption deductions. These offset the ordinary income first. It's possible to have capital gains income that equals or exceeds the total taxable income. So, in a year when one expects large capital gains, lowering ordinary income and maximizing adjustments and deductions can be even more rewarding than normal. -Mark Bole
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Someone please poke the holes in these thoughts.
HYPOTHETICALLY, are there any provisions I am overlooking that prevent my parents (high tax bracket) from gifting $48k in appreciated stocks to me and my wife (low tax bracket). We then sell them in 2008, realize the CG at 0%, repurchase the stocks, and regift them to my parents. Unfortunately, my wife and I are just barely above the 15% tax bracket, but suppose we weren't. Or could they gift to another, younger family member that has little or no income. Would AMT ever apply? Thanks
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Since this is all part of a pre-arranged plan, there are no true gifts involved, the "gifts" are shams, and the whole thing is tax fraud.
--
Rich Carreiro snipped-for-privacy@animato.arlington.ma.us

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My family exchange gifts as part of a pre-arranged plan too. At birthdays and Christmas, and sometimes (shudder) just for the hell of it.
You think that this is some sort of tax fraud that we should turn ourselves into the IRS for?
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If these gifts are somehow affecting your income tax returns, yes. -- Phil Marti Clarksburg, MD
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In the original question, capital gains were being gifted for the purpose of avoiding taxes. Is your family doing that?
Gifting to avoid capital gains taxes can be a tax planning strategy, but structuring a transaction so that the original gift or its proceeds are returned to the gifter is tax fraud since it is not really a gift.
Over the last 40 years, I have rarely given gifts to any of my relatives except my lovers and my children. This year I sent each of my father's wives and children with whom I am still on speaking terms a set of etched English Pub Glasses (See: http://www.tinyurl.com.yr2dar ). Of course, to avoid the year end mail crunch, I waited until mid-January to place the order. Thus, the heart attack reports have yet come in.
Dick
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If the gift exchange lowered your income tax, and the "gifts" were given only on the condition of receiving a "gift", then yes, in fact, you should. What part of "it's not a gift unless there are no strings attached", substance over form", and "step transaction doctrine" haven't you heard of? In any event, in the original poster's scheme, it's pretty clear that the recipients of the "gift" are only getting the "gift" because they are giving the money right back after selling the stock. So there's no gifting going on, the "giver" is treated as if he sold the stock himself, and he needs to report it that way on his return. -- Rich Carreiro snipped-for-privacy@animato.arlington.ma.us
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If you are giving each other phony gifts to evade income taxes you should be paying on disposition of the "gift" items, then yes, you should turn yourselves in. << ======================================================= >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2006) - All rights reserved. >> << ======================================================= >>
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No, but the only reason you know that the original questioner planned to avoid tax was that he detailed all the proposed steps for you and explained his intent! But I see the objection isn't so much that the gift exchange is "pre-arranged"; rather, it is the claim that the gifts themselves are a sham. Which brings up an interesting point (to me). Here we have several transactions, each of them "tax free", unreportable, and legal in their own right (we have only a confession to indicate otherwise), somehow made collectively illegal by the subjective analysis that they are a scam. Are there other areas in tax law where this is true too? Sounds more like a loophole to me, rather akin to stock trading to avoid taxes that got plugged with the "wash sales" rule. I'd expect to see something in the code clarifying what that rule is. Presumably the collective outrage of a number of regular contributers here is based on more than simply a sense of injustice that someone might even think to try such a thing!

So would gifting stock one Christmas from A to B, followed by a gift of cash from B to A the following Christmas be illegal? What about gifting back 10 years later? I mean, absent of some sort of written "quid pro quo" contract, how would anyone prove they weren't gifts? If my parents gift me stock which I then sell in a lower tax bracket, am I forever forbidden from giving them a gift in return, since it might have been purchased with "the original gift or its proceeds"?? Somehow I think this needs more analysis than just an appeal to the "step transaction doctrine". It needs a a set of definitive rules.

As long as each individual glass is valued at less than $12K ($24K if married filing jointly), no one need have a heart attack here! Moderator: The heart attack is from getting a gift from me!
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As far as I'm aware it's a judge-made rule to do equity by linking together interdependent steps. The step-transaction doctrine has been approved by the Supreme Court.

If it looks like a quid pro quo it may well be treated as one. I was once involved in a case where two people set up and funded trusts for the other's children. The court treated it as each setting up a trust for his own kids.

There is no one-size fit's all in this case. It's a very subjective situation, and each case must be analyzed on its own merits. Stu
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