With spring college graduations finishing up for the year, a new cohort of graduate students will begin school later this summer. Among these students will be many former military service members. A typical path for service members, especially officers, often involves graduate school as part of the transition from active duty to civilian employment. While the GI Bill covers some or all tuition costs and pays BAH, graduate students often rely on savings or student loans to pay the remaining expenses. As such, their taxable income is low or zero for the time they are attending school, creating a tax planning opportunity.
This period of low income creates a tax planning opportunity and, after this nearly decade-long bull market in U.S. stocks, this tax opportunity is significant for current graduate students. For 2018, long-term capital gains rates are taxed at 0% (yes, you read that correctly) up to $38,600 for single filers and $77,200 for those who are married filing jointly. In other word, students who have significant unrealized capital gains in taxable accounts (not including IRAs or TSP), long-term capital gains are tax-free up to those thresholds I just mentioned.
For example, a married couple with a taxable account and $50,000 in long-term, unrealized capital gains would pay nothing in taxes assuming no other sources of income. So how does one take advantage of this opportunity? It’s amazingly simple. Identify the investments with the capital gains that you want to lock in, sell them, and a few minutes later, repurchase them. It’s that simple. This process resets the tax basis for the selected investments, reducing future taxes
What about the Wash Sale Rule? It doesn’t apply in this situation. Wash sales only apply to realized capital losses. Typically, tax rules discourage the capital gain lock-in that I suggest because most people don’t go through a planned, long-term period of zero income.
A few caveats. First, depending on the exact timing of new investments and dividends, it’s also possible to trigger short-term capital gains which are taxed at ordinary income tax rates. If the short-term gains exceed the standard deduction, then the account owner will face additional taxes at their marginal tax rate. Second, this opportunity applies to federal taxes only. State income taxes rules vary. Readers shouldn’t take this article as clearance to execute the strategy I’ve overviewed without proper analysis of their individual situation, preferably with the help of a qualified adviser.
Are you interested in learning more about financial planning and investing? Please visit my website to learn about how I help our service members and veterans plan for and achieve financial independence. You can also contact me at Derek.Merkler@Parsonex.com.
My blog discusses a myriad of financial topics and challenges, book reviews, and commentary on current events in the financial world to benefit our military and veteran community. I attempt to be as thorough as possible when examining each subject but can never account for every possible scenario. Please remember to consult with your own advisers for advice on your particular situation. Thank you for reading!