Take A Look At Tax Bracket When Taking Capital Gains

The law provides a break for long-term capital gains - that is, profits from the sale of stocks, bonds, land and other investment property - provided that the assets are owned for more than one year.

The top tax rate on ordinary income is 39.6 percent, but the maximum tax rate on long-term capital gains is 28 percent.

Unfortunately, this tax break applies only if an individual’s taxable income puts him or her above the 28 percent tax bracket. Only wealthy and upper-middle-income taxpayers taxed at the 31 percent, 36 percent or 39.6 percent rates will benefit from this provision.

For example: Luisa Cardenas, a single taxpayer with $16,000 of taxable income, is in the 15 percent bracket. Her unmarried cousin, Teresa Soto, with $120,000 of taxable income, is in the 36 percent bracket.

Both realize long-term capital gains of $5,000 on a sale of stock.

Cardenas’ gain will be taxed at 15 percent, the same as her other income. She will not enjoy any capital gains tax savings.

In contrast, Soto will pay 28 percent tax on her capital gain, eight percentage points less than the rate on her other income.

On the surface, it would appear that the capital gains tax break has extremely limited application. For the low- to middle-income taxpayer (15 percent or 28 percent tax bracket) the 28 percent maximum rate on capital gains does not apply.

In contrast, for wealthy taxpayers only a small savings applies.

However, the provision might have significant year-end importance to taxpayers who anticipate dropping from the 28 percent bracket in 1995 to 15 percent next year. If a sale is made and capital gain is recognized in 1995, the gain will be taxed at 28 percent. A deferral until 1996 will result in a savings of 13 percentage points.

If you are in the 15 percent bracket in 1995 but anticipate being in a higher bracket in 1996, consider this strategy:

Sell a stock or other security before the year is over, to lock in the lower 15 percent rate. Then, if you believe it will continue to appreciate, immediately repurchase the security.