Temporary lower capital gains rate is complex

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Back in 2003, Congress lowered the capital gains rate for people in the two lowest federal tax brackets to zero -- but only for 2008 through 2010.Ever since, people in the lower brackets have dreamed of waiting until 2008 to sell a highly appreciated home or other assets and getting off tax free. But before you put your home on the market or sell your long-held stocks, understand this freebie.Even if you fall into the two lower brackets, your tax-free gains are limited. The most you could save is around $3,200 if you're married or $1,600 if you are single. Most eligible people will probably save less.Retired people with significant assets but no income from a job will probably benefit most.Here's how it works: Everyone falls into a certain tax bracket depending on taxable income, which is income from all sources minus exemptions and deductions. There are six federal tax brackets: 10, 15, 25, 28, 33 and 35 percent. These tax rates apply to income from a job, business, taxable interest and most other sources. This is known as ordinary income.A second, lower rate -- the capital gains rate -- applies to most long-term capital gains and qualified stock dividends. Capital gains come from the sale of investments and other assets. To qualify for it, you must hold the asset more than a year.Before this year, people in the 10 and 15 percent brackets paid 5 percent on long-term capital gains. Through 2010, they'll pay zero. Everyone else will continue to pay 15 percent on long-term capital gains and dividends.If you're in the two lower brackets, there is a limit to your tax-free gains.Suppose your ordinary income puts you in the 15 percent bracket, but you sell an appreciated asset that generates a long-term capital gain. Anything over the bracket will be taxable, explains Bob Scharin, senior tax analyst with Thomson Reuters' tax and accounting business.For 2008, the 15 percent bracket ends when taxable income exceeds:-- $65,100 for married couples filing jointly-- $43,650 for heads of households-- $32,550 for singles and married people filing separatelyRemember that taxable income is what's left after you have subtracted all your deductions and personal exemptions. Your gross income could be higher than the amounts above and you could still qualify for the zero percent rate -- as long as your taxable income doesn't exceed those amounts."A married couple, with $90,000 in adjusted gross income and two dependent children, would have about $65,100 in taxable income," Scharin says.Even if your taxable income exceeds the limits, you could get some benefit from the zero rate if part of your income comes from long-term capital gains.Suppose a married couple has $70,000 of taxable income. This includes $60,000 in ordinary income plus $10,000 in long-term capital gains.Scharin says this couple will pay no tax on $5,100 of gains -- the difference between their ordinary income and the top of the 15 percent bracket. The remaining $4,900 of gain will be taxed at 15 percent, the capital gains rate for the top four brackets.There are some big caveats:-- The zero rate only applies to assets held more than one year and to qualified corporate stock dividends. Most dividends from real estate investment trusts don't qualify. Gains on the sale of assets held one year or less are taxed as ordinary income. -- Gains on the sale of collectibles, such as antiques or artwork, don't qualify for the zero rate. Long-term gains on collectibles are taxed at ordinary income tax rates, but not more than 28 percent.-- The zero rate applies only to assets held in taxable accounts. It doesn't apply to money coming out of regular deductible individual retirement accounts, 401(k) plans and the like. That money is taxed as ordinary income.If you qualify for the zero rate, the most you could save on capital gains tax is:-- $3,255 for married filing jointly-- $2,182.50 for heads of households.-- $1,627.50 for singles and married filing separatelyTo realize the savings, all your income would have to come from capital gains and none from ordinary income, Scharin says.Suppose you're married and have at least $65,100 of taxable income from capital gains and no ordinary income. You'll save 5 percent (the old capital gains rate) on $65,100, or a total of $3,255.In reality, most people have a combination of ordinary income and capital gains, so their actual savings will be less.It's never smart to sell assets simply for tax reasons, but if you're in one of the two lower brackets, it could make sense to sell some assets by 2010 to take advantage of the zero percent rate. E-mail Kathleen Pender at kpender(at)sfchronicle.com.)(Distributed by Scripps Howard News Service, www.scrippsnews.com.)