I recently sold a vacant lot, and now have a capital gain of $10,000. Can I contribute to an IRA and a 403(b) retirement account to offset the taxes?
The short answer to the question is yes, but it depends on your specific facts and circumstances.
Capital gains are taxed for federal tax purposes as either long-term or short-term (for property held less than one year). Short-term gains are taxed like ordinary income at the tax rates in effect for each taxpayer based on his or her overall income and deductions. Long-term rates are discounted, and for 2018 they are 0 percent, 15 percent, or 20 percent, depending on the level of overall taxable income and your filing status. For a single filer, the capital gains tax rate is 0 percent for total taxable income up to $38,600 ($77,200 for married couples filing jointly); 15 percent when taxable income including the gain amount is between $38,601 and $425,800 ($77,201 and $479,000 for married couples filing jointly), and 20 percent when taxable income exceeds $425,800 ($479,000 for married couples filing jointly). The capital gain tax itself is calculated separately from and added to the regular tax.
If there is a capital gain tax based on the rates and income levels above, taxpayers can offset those gains to reduce their taxes in a number of ways. Increasing tax deductions (by contributing to a retirement account, for example) to offset the capital gains tax is a basic approach that works. The question becomes how much deduction (or retirement plan contribution) is needed to offset the long-term capital gain tax. Deductions reduce the regular tax based on the regular tax rates applied to other income. Regular tax rates for single filers are higher at 10 percent (for taxable income up to $9,524), 12 percent ($9,525 to $38,699), 22 percent ($38,700 to $82,499), 24 percent ($82,500 to $157,499), 32 percent ($157,500 to $199,999), 35 percent ($200,000 to $499,999), and 37 percent ($500,000 and over). For married joint filers, the income levels are exactly double that of single filers listed here. Once you know your marginal tax bracket, you can calculate how much of a deduction is needed to offset your capital gains tax.
Contributing to an IRA or a 403(b) to reduce your taxable income depends on whether you qualify. To contribute to a 403(b), one typically must be working, eligible to participate in the employer plan, and earning enough to contribute to the plan to get the desired tax benefit. Ignoring whether the employer provides a matching contribution or not, the capital gain tax calculated based on rates above can be divided by the regular tax rate to determine the amount of retirement plan contribution needed to offset the capital gain tax. So, if the capital gain tax is 20 percent of a $10,000 long-term capital gain (or $2,000), a single filer would be in the 35 percent regular tax bracket, so it would take a $5,717 contribution ($2,000 / 35 percent) to the 403(b) to offset the capital gain tax. The same math would apply to an IRA contribution, if eligible, and made out of earned income (typically wages or self-employment earnings). IRA deductions are limited to $5,500 per year for those age 49 and under, and to $6,500 for those 50 and over. Also, when the taxpayer or spouse is covered by an employer retirement plan, earnings would need to be below $63,000 if single or $101,000 if married to get the full IRA deduction. Even though IRA contributions are available out of earned income up to the annual limits, they may not be deductible based on total income if covered by an employer plan. At the income levels assumed above, contributing to the 403(b) would produce the desired effect, while IRA contributions would not be deductible based on income.
As stated previously, a more accurate answer really depends on your circumstances and where you fit in the scenarios demonstrated above. I encourage you to consult a CPA with your details to determine your specific tax responsibilities.
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Answered by: Thomas N. Alvaré, CPA, is managing principal with JFS Wealth Advisors in Doylestown, Pa.