Capital Gains tax one year rule

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Topic Author
tsampilo
Posts: 11
Joined: Thu Feb 04, 2021 1:07 pm

Capital Gains tax one year rule

Post by tsampilo »

Hey everybody.

I have a plan and I want to make sure I have everything understood properly.

I invested around $20,000 in a taxable account on 02-05-2021.
I make less than $40,000 a year.
I want to max out my Roth IRA for 2021 and 2022 but don't have enough money to contribute to it right now.

My plan is to wait until 02-05-2022 (February of this upcoming year), so that my investments have been in the taxable account for at least a year, and take $12,000 out. Since I make less than $40,000 a year and the amount has been in my account for a year, triggering longterm capital gains tax, I should be taxed at 0%, correct?
With my $12,000 that I pulled out, I would then contribute $6,000 to my 2021 Roth IRA (I can contribute to the 2021 year since it is before filing taxes in April, correct?). Then I would use the other $6,000 to contribute to the 2022 Roth IRA (once I hit the earned income of $6,000 of course).

Is there anything wrong with my information here? Any fundamental flaws? Is my plan stupid? I would love any and all input.

Thanks in advance,
-T
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samsoes
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Re: Capital Gains tax one year rule

Post by samsoes »

Great plan, but consider state income tax. Here in the Great Tax State of Connecticut, all capital gains are (state) taxed at ordinary income rates. (The gains taxed at 0% still are part of your AGI -- adjusted gross income.)

Also, you're assuming there will be a gain next spring and not a loss. You never know...
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Affable at 50
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Joined: Fri Dec 27, 2019 1:34 am

Re: Capital Gains tax one year rule

Post by Affable at 50 »

tsampilo wrote: Fri Sep 24, 2021 3:16 pm Hey everybody.

I have a plan and I want to make sure I have everything understood properly.

I invested around $20,000 in a taxable account on 02-05-2021.
I make less than $40,000 a year.
I want to max out my Roth IRA for 2021 and 2022 but don't have enough money to contribute to it right now.

My plan is to wait until 02-05-2022 (February of this upcoming year), so that my investments have been in the taxable account for at least a year, and take $12,000 out. Since I make less than $40,000 a year and the amount has been in my account for a year, triggering longterm capital gains tax, I should be taxed at 0%, correct?
With my $12,000 that I pulled out, I would then contribute $6,000 to my 2021 Roth IRA (I can contribute to the 2021 year since it is before filing taxes in April, correct?). Then I would use the other $6,000 to contribute to the 2022 Roth IRA (once I hit the earned income of $6,000 of course).

Is there anything wrong with my information here? Any fundamental flaws? Is my plan stupid? I would love any and all input.

Thanks in advance,
-T
Your plan is sound. I would note that you do have to wait until you’ve earned $6,000 in 2022 to contribute the maximum amount. As long as you’ve earned enough by the end of 2022 that is all that counts.

Watch for an announcement at the end of October for the new contribution limits. Due to strong inflation I am expecting a small bump.
Topic Author
tsampilo
Posts: 11
Joined: Thu Feb 04, 2021 1:07 pm

Re: Capital Gains tax one year rule

Post by tsampilo »

Thanks for the replies! Another question occurred to me: Does it matter that I continually contributed to my taxable account? For example, I put $20,000 in it 02-05-2021 but each month after I continually contributed more and more money. The last time I contributed was July. Since I am only pulling out $12,000 next year (02-05-20220 and my initial $20,000 has been in for longer than a year, it still qualifies as one year in the account right? even though my July contribution would clearly have not been in the account for a year?
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retiredjg
Posts: 54082
Joined: Thu Jan 10, 2008 11:56 am

Re: Capital Gains tax one year rule

Post by retiredjg »

I think you have the right idea, but might need to modify a little or at least be careful about the limits.

In 2021, if a single person's total taxable income is less than $40,400, any long term capital gains that are included under that $40,400 limit are taxed at 0%. In other words, the gains you take will be part of that $40,400.

On the other hand, the $40,400 is taxable income, which is less than what you make. You must subtract your deductions or the standard deduction ($12,550) from what you make to get your taxable income. See the number on line 15 of last year's income tax return for what your taxable income was last year.

The question arises whether Roth IRA is the best choice for you. At your income level, you are probably eligible for the saver's credit on your taxes and you might get a larger saver's credit if you save money in a work plan (if you have one).

The way your plan could backfire is if you unexpectedly get a new job or a bonus or a large raise during the tax year. Of course, in the long run, that might be more beneficial than not paying the long term capital gains rates when you take the money out of your taxable account.
livesoft
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Re: Capital Gains tax one year rule

Post by livesoft »

it is also possible that your taxable investment will NOT have a gain by the time February 5, 2022 rolls around.ves

Furthermore, if your investment pays a dividend, then note that shares purchased with reinvested dividends get their own "starting" date and will have a different date for when those shares would be considered held long-term. Your question about pulling out $12,000 would be fine if you identified the shares that you sell to be those shares held long-term and avoided selling any shares held short-term.

For qualified dividends to remain qualified and get the preferential qualified ordinary income tax rate, the shares that paid such dividends have a personal holding period of 61 days out of a specific 121 day period. See the IRS rules on this.
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HomeStretch
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Re: Capital Gains tax one year rule

Post by HomeStretch »

Turn off automatic dividend reinvestment in your Taxable account (if it’s turned on). The dividends will go into your settlement account. You can then use that cash to start funding your Roth IRA. It’s not going to be a lot of $, but no sense reinvesting just to turn around and sell the tax lot.
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retiredjg
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Re: Capital Gains tax one year rule

Post by retiredjg »

tsampilo wrote: Fri Sep 24, 2021 3:35 pm Thanks for the replies! Another question occurred to me: Does it matter that I continually contributed to my taxable account? For example, I put $20,000 in it 02-05-2021 but each month after I continually contributed more and more money. The last time I contributed was July. Since I am only pulling out $12,000 next year (02-05-20220 and my initial $20,000 has been in for longer than a year, it still qualifies as one year in the account right? even though my July contribution would clearly have not been in the account for a year?
Whether a gain is short or long term depends on when that particular share was bought. You might want to use the "specific identification of shares" method to pick the shares to sell.

Also, if you bought on Feb 5 one year, I would not sell until Feb 7 or 8 of the next year. It will not hurt you to have a couple of days buffer just in case your shares did not actually get purchased and on the books until Feb 6.
livesoft
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Re: Capital Gains tax one year rule

Post by livesoft »

Feb 5, 2022 is a Saturday anyways.
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gobel
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Re: Capital Gains tax one year rule

Post by gobel »

You don't pay tax on the whole 12k that you take out, only on the profit. So you might even be able to sell some of the shares now (eg the batches purchased with the highest prices) and owe not much tax, instead of waiting for next Feb.

You have to make sure that you can choose which lot to sell (always true for stocks, but an option for mutual funds) - called selling by specific id of "specid".
Last edited by gobel on Fri Sep 24, 2021 3:59 pm, edited 1 time in total.
exodusNH
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Re: Capital Gains tax one year rule

Post by exodusNH »

tsampilo wrote: Fri Sep 24, 2021 3:35 pm Thanks for the replies! Another question occurred to me: Does it matter that I continually contributed to my taxable account? For example, I put $20,000 in it 02-05-2021 but each month after I continually contributed more and more money. The last time I contributed was July. Since I am only pulling out $12,000 next year (02-05-20220 and my initial $20,000 has been in for longer than a year, it still qualifies as one year in the account right? even though my July contribution would clearly have not been in the account for a year?
Each purchase is tracked separately and so matures differently. E.g. if you bought $250/week every week starting on 05-Feb-2021, then your first $250 is available at the long-term rate on 06-Feb-2022. Then on 13-Feb-2022, your next $250 is a year old, and so on. You've also been paid some amount of dividends. If you reinvested, then you've got a handful of little purchases (monthly, quarterly, or yearly depending on the fund) that are also tracked separately.
livesoft
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Re: Capital Gains tax one year rule

Post by livesoft »

Don't forget to count to more than one year like the IRS does as explained in IRS Publication 550:
IRS Publication 550 page 53 wrote:Holding Period
If you sold or traded investment property, you
must determine your holding period for the
property. Your holding period determines
whether any capital gain or loss was a
short-term or a long-term capital gain or loss.

Long-term or short-term. If you hold investment property more than 1 year, any capital
gain or loss is a long-term capital gain or loss. If
you hold the property 1 year or less, any capital
gain or loss is a short-term capital gain or loss.
To determine how long you held the investment property, begin counting on the date after
the day you acquired the property. The day you
disposed of the property is part of your holding
period.

Example. If you bought investment property on January 31, 2019, and sold it on January 29, 2020, your holding period is not more
than 1 year and you have a short-term capital
gain or loss. If you sold it on February 6, 2020,
your holding period is more than 1 year and you
have a long-term capital gain or loss.
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grabiner
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Re: Capital Gains tax one year rule

Post by grabiner »

samsoes wrote: Fri Sep 24, 2021 3:21 pm Great plan, but consider state income tax. Here in the Great Tax State of Connecticut, all capital gains are (state) taxed at ordinary income rates. (The gains taxed at 0% still are part of your AGI -- adjusted gross income.)

Also, you're assuming there will be a gain next spring and not a loss. You never know...
If there is a loss, that is even better for you. You can sell stock at a loss in your taxable account, and buy an equal amount of stock in your Roth IRA, so that you will keep the stock exposure and get rid of the tax cost. (If you do this, don't buy the same fund or a substantially identical fund in the Roth IRA; that would be a wash sale which would disallow the deduction on the capital loss.)
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