| Understanding the capital gains rules could mean lower taxes
when you sell an investment. Lower rates, shorter holding
period
For taxpayers in the 28% or higher bracket, the maximum tax rate is now 20% on gains
from capital assets, such as stocks and bonds, that are held more than 12 months.
Taxpayers in the 15% bracket now pay 10% on these gains. These rates also apply to real
estate gains, except that recaptured depreciation is generally taxed at 25%. The maximum
rate for collectibles, such as coins and antiques, held over one year is 28%.
Planning can increase return
What should the savvy investor do to maximize after-tax returns? That depends, since
many factors other than taxes affect investment decisions. However, careful planning can
make a significant difference in your investment return.
 Collectibles are generally less appealing
than other investments. Bonds are also less attractive, because they usually produce more
ordinary income than capital gains. For the same reason, high-dividend stocks are less
desirable than low-dividend stocks. Mutual funds that make minimal dividend distributions
are also relatively more appealing.
If you have children in the 15% tax
bracket, you may want to consider gifting appreciated stock to them. They can then sell
the stock and pay as little as one-half the taxes you would pay. (Watch out for the kiddie
tax, however.)
If your employer offers stock options, be
sure to manage their exercise and sale to maximize your long-term capital gains.
You pay ordinary tax rates on taxable
distributions from your retirement accounts, regardless of how much capital gains income
they contain. Therefore, you may want to evaluate the assets in these accounts in
relation to your non-retirement investments. For example, the closer you are to retirement, or the
higher you expect your retirement tax rate to be, the more you may benefit from keeping
assets with long-term gain potential out of your retirement accounts.
Be careful with capital losses. The timing
and size of your capital gains and losses could affect whether you achieve maximum tax
benefit from your losses.
Be aware that the exercise of substantial
incentive stock options can trigger the alternative minimum tax, with all its related
complications.
With the big gap between long-term capital
gain and ordinary tax rates, good record-keeping is very important to ensure capital gains
treatment. Also, when determining if you've met the required long-term holding period,
remember that your holding period starts the day after you purchase an asset and includes
the sale date.
Note: Effective January 1, 2001, the 20% capital gains rate
drops to 18% for assets purchased after December 31, 2000, and held
for more than five years. For lowest bracket taxpayers, the 10% rate drops
to 8% for assets sold after December 31, 2000, and held for more than
five years.
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The capital gains rules can create sizable tax
savings, but because of their complexity, they can also bite. If you are contemplating a
major capital transaction, or if you would like me to review your overall capital gains
picture, please call my office or send your questions to me via 