Case study
The 0% capital gains bracket: when switching costs almost nothing
Most of these case studies are about one number: the tax bill you pay the day you sell. But some years that bill is close to zero. If your income dips low enough, long-term gains can be taxed at 0% federally, and the whole switch math changes.
A lot of people have one of these years and never notice. Early retirement before Social Security kicks in. A sabbatical. A year between jobs. A spouse taking time off. If that's you, this is the year to look hard at any switch you've been putting off.
How the 0% bracket works
Long-term capital gains and qualified dividends get their own rates: 0%, 15% or 20%. Which one applies depends on your taxable income, with your gains stacked on top of your ordinary income.
For 2026, a married couple filing jointly pays 0% on long-term gains up to $98,900 of taxable income. For single filers, it's $49,450. And taxable income is what's left after deductions, so with the 2026 standard deduction of $32,200 for a married couple, the top of the 0% bracket is really about $131,100 of total income.
Two things trip people up:
- Your ordinary income fills the bracket first. Wages, pension, IRA withdrawals and interest come first. Gains only get whatever room is left.
- It's not a cliff. Gains that spill over the top are taxed at 15%. Only the part that fits gets the 0%.
The setup
Same switch as the first case study, but in a quiet year:
- $200,000 in an S&P 500 index fund in a taxable account, with $120,000 of cost basis, so an $80,000 long-term gain
- A married couple with $60,000 of ordinary income this year and no other investment income
- A 5% state tax on capital gains
- In a normal year they'd pay 15% federal, so 20% all in
- The index fund earns 7% a year, and they'd hold for 20 years
After the $32,200 standard deduction, their taxable income is $27,800. That leaves $71,100 of room in the 0% bracket.
What the switch costs now
Sell everything this year, and $71,100 of the gain is taxed at 0%. The other $8,900 spills into the 15% bracket, which is $1,335. Add $4,000 of state tax and the total is $5,335, instead of $16,000 in a normal year.
Or split the sale. Sell enough in December to realize $71,100 of gain, and the rest in January, when there's a fresh year of room. Now the federal bill is zero and only the $4,000 of state tax is left.
| When they sell | Tax today | 20-year hurdle |
|---|---|---|
| A normal year (20%) | $16,000 | 7.33% |
| The 0% year, all at once | $5,335 | 7.01% |
| Split across two years | $4,000 | 6.98% |
| Split, in a state with no income tax* | $0 | 6.90% |
The hurdle is the return the new fund needs to earn for switching to break even, after every tax on both paths, assuming they'd eventually sell either one at 20%. *With no state tax, the later rate is 15%, and the normal-year hurdle would be 7.25%.
In a normal year, the factor tilt has to beat the index by about a third of a point a year just to pay back the tax. In the 0% year, it barely has to beat it at all. The hurdle is at or below the index fund's own 7%.
Why can the hurdle fall below 7%? Because selling in a 0% year resets the cost basis. The new fund starts with a $196,000 basis instead of $120,000, so there's less gain to tax at the end. That's worth something even if the new fund does no better.
Not switching? Harvest the gain anyway
You don't need a new fund to use the 0% bracket. You can sell and immediately buy the same fund back. The wash-sale rule only applies to losses, so there's no waiting period for gains.
Nothing about the portfolio changes except the cost basis, which jumps to today's value. In a state with no income tax, that's free, and it saves the $12,000 of federal tax (15% of the $80,000 gain) they'd otherwise owe whenever they eventually sell. Some people do this every year they're in the 0% bracket.
State tax changes the picture, though. With the 5% state tax, resetting the basis costs $4,000 today to save $16,000 decades from now, and over 20 years that comes out only about $2,800 ahead. Worth doing, but not a windfall. For gain harvesting on its own, your state rate matters a lot.
The catch: other things key off your income
Realized gains raise your adjusted gross income, even when they're taxed at 0%. That can cost you in other places:
- ACA health insurance. If you buy marketplace coverage, higher income can shrink or wipe out your premium tax credit. For early retirees, this is often the biggest hidden cost.
- Social Security. Extra income can make more of your benefits taxable.
- Medicare premiums. At higher incomes, Medicare charges a surcharge based on your income from two years earlier.
- State taxes. Most states tax capital gains like ordinary income, with no 0% bracket.
- College financial aid. Gains count as income on aid forms.
None of these show up in the federal bracket table. Run your own numbers through tax software, or ask a tax pro, before you sell.
A few practical notes
- Only long-term gains qualify. Shares held a year or less are taxed at ordinary rates.
- Watch fund distributions. Qualified dividends and year-end capital gain distributions use up the same room, and they often land in December.
- Leave a cushion. Your income isn't final until December 31. Many people aim a few thousand dollars below the line.
- Pick your lots. If you only need part of the room, sell the lots with the highest cost basis per share first so you move more money for the same gain.
Try it with your numbers
The full engine, free while it's in beta, has a field for the tax rate on today's sale, so you can price a low-income year separately from the rate you'd pay later.
Run the split-sale example in the full engine
Figures use 2026 federal brackets and the standard deduction for married couples filing jointly, a single position, flat rates, steady 7% returns, and both paths fully sold at the end at 20%. Tax brackets and deductions change every year. These are illustrations of the arithmetic, not a recommendation to buy or sell any security. Check your own situation with a tax professional.