Where Is the Tax-Free Line for Capital Gains and Dividends?

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The stock market is one of the best ways for ordinary people to grow their wealth, and you don’t need to be wealthy to start using it. What’s more, our friends in Washington, D.C., want to encourage that, so if your annual income falls below a certain threshold, you’ll pay no taxes on the portion you made on Wall Street. But, of course, when it comes to anything tax-related, there will be fine print and math. So, in this segment from the Motley Fool Answers July mailbag show, hosts Alison Southwick and Robert Brokamp, along with special guest Ross Anderson, a certified financial planner at Motley Fool Wealth Management — a sister company of The Motley Fool — help out a listener whose wages put him near the raw threshold but whose investment income puts him over. Does he qualify? Probably. And more interestingly, he’s in a position to make some other profitable maneuvers with his portfolio.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on July 30, 2019.

Alison Southwick: The next question comes from Brent. “I know if you make zero to $38,600 your capital gains tax rate is 0%. Does that include your capital gains dividends? For example, I made $37,000 last year but received $3,000 in dividends and capital gains.

Because I’m now over $38,600 will I owe tax on the dividends and gains? Additionally, is this income amount before or after deductions and credits?”

Robert Brokamp: Let me clarify a few things, here, for you Brent. I’m sure you understand this, but I want to make sure everyone else understands it. When he’s talking about these lower rates on dividends and capital gains, we’re talking about qualified dividends. Most people who hold onto a stock for more than 120 days means your dividends are going to be qualified. I just want to make sure everyone knows that. And we’re talking about long-term capital gains, so stocks that you hold onto for at least a year.

And he highlights something that is really interesting, in that if you are under a certain income threshold, your qualified dividends and long-term capital gains are tax-free. You don’t pay any taxes on that. Now he has the number from last year –2018. The number for this year, 2019, is up to $39,375 if you’re single. If you’re married filing jointly, it’s up to $78,750.

And part of the answer to his question is that is your taxable income. So you start with your gross income and you take away your deductions and all that type of stuff. So you could be a married couple of earning almost $100,000 and still have some of your long-term capital gains and qualified dividends be tax-free.

Now, what happens in his situation is he had $37,000, but then he had $3,000 in dividends and gains. The part up until that threshold will be tax-free. The part over that threshold you will be taxed on, but not the whole part; just the part that is beyond the threshold.

For anyone who is in this situation — who’s in a lower tax bracket this year — it makes sense, actually, to even just sell the stocks up until the point where you’re not paying any taxes and then you can buy them back immediately and reset your cost basis. It sounds a little like tax-loss selling, but this is tax-gain selling, in a way. With tax law saying you can’t buy the same thing back in 30 days, it’s not true with tax-gain selling. Sell it, recognize just enough capital gains so it’s tax-free. Buy it again immediately and you reset your cost basis.

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