Articles

New Capital Gains Rate
By: Thomas R. Cribbins, CPA
As a result of the enactment of the taxpayer relief act of 1997, the gain resulting from a sale of capital assets may be eligible for a tax rate of 18%. Currently the capital gains rate is 20% for assets held more than one year. Under the new rules, assets held for more than five years which would otherwise be taxed at a 20% rate will be taxed at an 18% rate. However, for an asset to qualify, its holding period must begin after December 31, 2000. Therefore, it wonít be until 2006 before the 18% rate can be realized. For taxpayers in the 15% income tax bracket (single taxpayers with income between ($0 - $26,250 in 2000) current law allows long term capital gains to be taxed at 10%. Under the new rules, capital gains incurred which would have been taxed at 10% would qualify for a reduced 8% rate. Unlike the holding period for assets taxed at 18% the 8% tax rate applies to asset held for more than five years regardless if they were acquired prior to December 31, 2000. Thus, beginning in 2001 some gain may be taxed at 8%.

Neither the 8% nor the 18% rate applies to the sale of collectibles (taxed at a maximum rate of 28%), unrecaptured Section 1250 gain (taxed at a maximum rate of 25%), and Section 1202 gain (part of the gain from the sale of certain qualified small business stock is taxed at 28%). In order for taxpayers to ensure that their assets will be eligible for the 18% capital gains rate beginning in tax year 2006, a deemed-sale-and-repurchase election can be made. A taxpayer may elect to treat certain assets held on January 1, 2001, as having been sold and then reacquired on the same date. If the election is made, any gain recognized is subject to the applicable current capital gains rate. A loss from a deemed sale is not allowed, but the asset will be eligible for the 18% rate on future gain.

The assets that can avail to the election are both capital assets or property used in a trade or business (IRC ß 1231 assets). The election is made on an asset by asset basis. Therefore, you can elect to subject some of your assets to the election while omitting others.

The election is available to taxpayers (other than corporations) and pass-through entities. Pass-through entities include mutual funds (or other regulated investment companies), real estate investment trusts, S corporations, Partnerships, estates, trusts, and common trust funds. For grantor trusts the grantor of the trust must make the election. The election is made by reporting the deemed sale(s) on the timely filed (including extensions) 2001 tax return. With the use of extensions, the taxpayer can defer his/her decision until October 15, 2002 on whether or not to make the election. Once the election is made and reported to the IRS, it is irrevocable.

The election may make sense where a taxpayer has realized losses for tax year 2001 and he or she holds assets which are expected to appreciate greatly during the next five years. Another example of when it may be beneficial to make the election, is if a taxpayer sells a stock in 2002 for a large gain. If the taxpayer incurs the gain before filing his or her 2001 tax return, he or she can make the election and thus spread the gain over two years. For example, a taxpayer sells xyz stock on March 3, 2002 for a gain of $200,000 xyz has appreciated $100,000 during tax year 2001. If the deemed-sale-and-repurchase election is made the taxpayer would recognize a $100,000 gain in 2000 and 2001. This may be beneficial to prevent the phase out and reductions of itemized deductions, exemptions and credits. However, care should be taken when making the election since the election causes immediate recognition of tax. Another shortfall is if the taxpayer makes the election, but upon the actual sale the taxpayer happens to fall into the lower tax bracket, he or she would have subjected the gain to a higher rate than necessary.

It is difficult to ascertain whether this election should be made. The election will depend on each taxpayers particular situation. If you feel this opportunity may be right for you, please contact your Sheehan Service Partner to discuss how this election may best serve you.

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