Question: I am 49 years old, single and make $32,000 a year. I have just received $18,000 from the sale of a house and do not plan on buying another. About how much in taxes will I have to pay? Is it better for me to invest in a 91-day certificate at 13 percent or tax-free bonds at 14.2 percent?
Answer: There really isn't enough information in your letter for me to give you an answer with any degree of confidence. But if I make a couple of assumptions, perhaps you can extrapolate to fit your specific circumstances.
First: the $18,000 you received in cash is probably not what you will report as capital gain for income tax purposes. The actual taxable gain may be more or less than that figure--but it will almost certainly be different.
The gain is determined by adding to the original purchase price any capitalized closing expenses plus the cost of all capital improvements while you owned the house, then subtracting any casualty losses claimed during the period of ownership.
Then subtract that number (the adjusted cost basis) from the net selling price (gross selling price minus all expenses of sale like legal fees, filing charges, etc.).
If we assume the $18,000 represents your capital gain on the sale, your federal income tax bite will be in the neighborhood of $3,000. If you have no dependents and take the zero bracket allowance (the old standard deduction), you end up in the 40 percent federal tax bracket.
You may be able to income-average for 1982. Just how much that would reduce the tax bite depends on your income history for the previous four years. If your income has been fairly consistent, I doubt if you will be able to get the tax on the $18,000 much lower.
With regard to the investment alternatives, there are factors to consider other than the yield. What you think will happen to interest rates, for instance--because the 91-day certificate must be rolled over every three months at the then-current rate, while the tax-free bond locks up the yield for a long term.
But on the arithmetic alone, the tax-free bond is obviously the better deal for you. In your tax bracket the 13 percent yield really comes down to 7.8 percent--not much more than half of what you would realize with 14.2 percent free of federal tax.
Q: When do you expect Series EE savings bonds to increase their interest rate? I keep reading they will go up but have yet to see it. I want to start buying bonds but prefer to wait until the bond interest increases. If I buy now at the 9 percent rate can I convert to the new interest rate when it is announced?
A: The Treasury Department has proposed, and the Congress is considering, a change in the rules to permit payment of a market-based rate on savings bonds.
If the Congress buys Treasury's proposal--and the signs are encouraging--the interest rate on all new Series EE bonds will be 85 percent of the average yield on five-year Treasury securities during the lifetime of the bond.
There will also be a guaranteed minimum return. If the average rate of return on Treasuries should fall substantially, a bond held at least five years will earn at least the guaranteed rate.
(Regardless of whether you earn the guaranteed minimum or a higher return, interest will continue to be compounded semi-annually as it is at present.)
There's no reason for you to wait to buy Series EE bonds, however. In the past, increases in the interest rate for new bonds were also applied to previously issued bonds--not retroactively, but starting with the first interest period after the new rate went into effect.
And Treasury Secretary Regan's proposal for the market-rate bonds specifically included a provision to cover bonds you already own.
If you hold the earlier bond for at least five years after the new rules take effect, your old bond will earn the same floating rate for that period as a newly issued bond (but at least the 9 percent rate, if the market rate should turn out to be lower).