Using Capital Losses to Free Up Headspace for Roth Conversions in 12% Tax Bracket

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OffGridder
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Using Capital Losses to Free Up Headspace for Roth Conversions in 12% Tax Bracket

Post by OffGridder » Thu Sep 20, 2018 2:55 pm

I know capital losses whether current or carryover will be wasted if used up on capital gains which would be taxed at 0% in the 12% tax bracket. However could those capital losses still have value by reducing your AGI and thus opening up "headspace" in the 12% bracket for taxpayers who are making Roth conversions to the top of the 12% bracket?

Please note, I am only addressing the case where the losses are consumed against captial gains already not subject to capital gains tax. I know the capital losses can offset up to 3K in ordinary income if there are no capital gains to offset.

Thank you,
Dave
"Goodness is the only investment that never fails." | H.D. Thoreau

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grabiner
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Re: Using Capital Losses to Free Up Headspace for Roth Conversions in 12% Tax Bracket

Post by grabiner » Thu Sep 20, 2018 5:26 pm

This strategy will work. If you convert up to the point where your total taxable income is $38,600 single, $77,200 married, you will pay no tax on your capital gains. For example, if you are single and take the $12,000 standard deduction, you can have income (including conversion) of $50,600. If you have $10,000 of long-term gains in addition, those would be taxed at 15%, but not if you have $10,000 of capital losses to offset the gain.

However, you shouldn't take long-term gains just to take them in this situation. It would be better to convert $3000 more this year, and keep the $7000 carry-over to next year, when you can convert an additional $3000 extra, or take gains if you need to take them.
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Re: Using Capital Losses to Free Up Headspace for Roth Conversions in 12% Tax Bracket

Post by #Cruncher » Fri Sep 21, 2018 8:42 pm

OffGridder wrote:
Thu Sep 20, 2018 2:55 pm
I know capital losses ... will be wasted if used up on capital gains which would be taxed at 0% in the 12% tax bracket. However could those capital losses still have value by reducing your AGI and thus opening up "headspace" in the 12% bracket for taxpayers who are making Roth conversions to the top of the 12% bracket?
Yes. Consider the following four cases:
  1. $10,000 long term capital gain and $40,600 ordinary income. For a single taxpayer taking the 2018 standard deduction this puts one at the maximum where no LTCG is taxed.
  2. Same as A except a $5,000 capital loss reduces the LTCG to $5,000. But there is no change in tax. I.e., the capital loss is "wasted".
  3. Same as A except an additional $5,000 Roth conversion increases the ordinary income to $45,600. Tax goes up $1,350 as $5,000 of LTCG is pushed into the 15% bracket.
  4. Same as A except both a $5,000 capital loss and an additional $5,000 Roth conversion. Tax goes up only $600 as the capital loss keeps any LTCG from being taxed.
Here is the detail as prepared on the Compare sheet of my Marginal Tax Rates spreadsheet:

Code: Select all

Floor: ord income 10% bracket           0    ------------------------->
Floor: ord income 12% bracket       9,525    ------------------------->
Floor: ord income 22% bracket      38,700    ------------------------->
Floor: LTCG & QDI 15% bracket      38,600    ------------------------->
                                   Case A    Case B    Case C    Case D
                                   ------    ------    ------    ------
LTCG & QDI                         10,000     5,000    10,000     5,000
Non-SS Ordinary Income             40,600    40,600    45,600    45,600
Adjusted gross income              50,600    45,600    55,600    50,600
Deductions plus Exemptions         12,000    12,000    12,000    12,000
Taxable Income                     38,600    33,600    43,600    38,600
LTCG & QDI Taxable                 10,000     5,000    10,000     5,000
Ordinary income taxable            28,600    28,600    33,600    33,600

Code: Select all

Taxable: ord income bracket 2      19,075    19,075    24,075    24,075
Taxable: ord income bracket 1       9,525     9,525     9,525     9,525
Taxable: LTCG & QDI bracket 2         -         -       5,000       -  
Taxable: LTCG & QDI bracket 1      10,000     5,000     5,000     5,000

Tax: ord income bracket 2           2,289     2,289     2,889     2,889
Tax: ord income bracket 1             953       953       953       953
Tax: LTCG & QDI bracket 2             -         -         750       -
Total tax                           3,242     3,242     4,592     3,842

LTCG       vs case A                         -5,000         0    -5,000
Ord income vs case A                              0    +5,000    +5,000
Tax        vs case A                              0    +1,350      +600

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