Quick Reference Capital Gains |
Happy New Year! A new lower capital gains tax Hold your investments for more than five years, and Congress will cut you a break -- a lower capital-gains rate. The rules are complicated, however. Here's how the rules work, along with a list of assets that don't qualify for the cut. By Jeff Schnepper Welcome to the new millennium! If you think taxes are going to get simpler this year, you probably think Santa Claus really did slide down your chimney to deliver those presents last month. However, the New Year did produce a small gift from Congress. A new rule on capital gains that cuts the potential tax rate -- if you wait long enough.
Our Congress likes capital gains -- it also apparently likes attorneys and accountants, because it insists on making the rules as complicated as programming a VCR (trust me, this is hard for those of us that are either mechanically handicapped or old enough to remember record players). But lower rates mean more money in your pocket if you follow the rules. So let's try to translate the gobbledygook. … Capital gains are the gains you make on the sale or exchange of capital assets. Capital assets include such things as stock, mutual funds, bonds, securities, real estate held as an investment and most properties held for personal purposes. (For a list of what doesn't qualify, click here.) If you sell property for more than its basis (usually its cost), you have a "capital gain." If you held the property for more than a year before selling, you get a lower tax rate on that gain. The Tax Relief Act of 1997 (as amended in the 1998 Reform Act) created the new rules, effective for sales after May 6, 1997. They're complicated, convoluted and maybe drafted by people who weren't thinking straight. Let's see what you think once we've gone over them. The old rules You must understand that these special rules apply only to long-term capital gains -- gains on sales made of capital assets held more than one year. If I bought the stock on Jan. 2, 2000 and sold it on Jan. 2, 2001, which was Tuesday, it's not more than one year, and ordinary income-tax rates apply to the gain. But, if I sold on Jan. 3, 2001, I would have a long-term gain and the special rules would apply. Generally, the maximum long-term capital gains tax rate is 20% (10% for individuals in the 15% tax bracket). These rates apply to individuals, estates and trusts. They also apply to the capital-gains portion of any alternative minimum tax you may have to pay and to any installment payments received, even if the original installment sale was made before May 7, 1997. The new rules The maximum 20%/10% long-term rates still apply for assets held more than 12 months. However, a new lower rate of 18% (8% for individuals in the 15% tax bracket) now applies for assets held more than five years. Be careful here -- the rules get complicated. If you're not in the 15% bracket. The five-year holding period and the reduced rate only apply to assets acquired after Dec. 31, 2000. If you are in the 15% bracket. The assets do not have to have been acquired after Dec. 31, 2000. Any five-year holding period that ends after Dec. 31, 2000 would qualify for the reduced 8% rate. Here are some scenarios of how the new rules may work. Assume you're in the 39.6% bracket. If you bought stock on or before Dec. 31, 2000 and held it for more than 12 months, your maximum capital-gains rate is 20%. Even if you didn't sell the stock until Jan. 2, 2006, your rate is still 20% because you bought the stock on or before Dec. 31, 2000. But, if you were in the 15% bracket in the year of the sale, you would qualify for the 8% rate because you held the stock for more than five years. When you originally bought the stock wouldn't be relevant, so long as you meet the five-year requirement. But we're not done yet. There's a special election that those in brackets higher than 15% may make. Remember, in order to qualify for the lower rates, those in brackets higher than 15% have to acquire the assets after Dec. 31, 2000. But you can elect to treat pre-Jan. 1, 2001 property as acquired on Jan. 1, 2000 and be eligible for the new five-year holding period. There's a cost. In order to make this election, you must treat the asset as if you sold it on Jan. 1, 2001 (or the next business day) at its fair market value. Then you'd pay the capital-gains tax on the profit from this "deemed" sale. Your five-year holding period would then begin on the date of your "deemed" sale. Unfortunately, if the value of the asset has decreased, you're not allowed to recognize your "loss." This special election applies to readily tradable stock, any other capital asset and certain property used in your trade or business. If you expect your investment's value to take off in the next few years, this election could save you significant tax dollars. In any case, knowledge is power. Know the rules and you have the power to minimize your tax liability. What doesn't qualify as a capital asset? A few things don't make the grade, and you should be aware of them. These include: • Inventory or other property held primarily for sale to customers. • Real or depreciable property used in a trade or business. • Accounts or notes receivable acquired from sales of inventory or services. • A copyright or a literary, musical or artistic composition owned by the creator or received from the creator by gift. • A letter or memorandum owned by the creator or received from the creator by gift. • Federal or state government debt issued at a discount and payable without interest at a fixed maturity date not exceeding one year from the date of issue. • Free U.S. government publications.
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