Capital gains rate reductions

Capital gains rate reductions

Host : OK, great. Now that we know a little more about luhman.org, let's wrap up our discussion of the new tax law.

We've got a good idea of the changes in IRAs, how about changes in the capital gains tax?

David : Here's another good example of a tax cut, but a cut which comes at the price of increased complexity. The new tax law reduces the maximum capital gains rate to 20 percent for assets held at least 18 months.

This is down from a maximum rate of 28 percent. If you're in a lower tax bracket, you might pay a capital gains rate of only 10 percent if you hold onto an asset for 18 months or longer.

Host : So where's the added complexity?

David : First, there's complexity associated with capital gains transactions made in the transition year of 1997. Assets sold early in the year, assets sold in the middle of the year, and assets sold late in the year all face different rates and holding periods. This makes 1997 complicated.

After 1997, things get a little easier, but there are still different rates for different holding periods.

If you hold onto your assets 18 months or more, you'll only pay the long-term rate of 20 percent on capital gains. This 18 month holding period is new. The magic number for long-term capital gains used to be 12 months, but now the magic number is 18 months.

If you hold onto assets for 12 to 18 months, you'll pay the mid-term rate of 28 percent. This concept of a mid-term rate is something new.

Finally, if you buy and sell assets in 12 months or less, you'll have to pay ordinary income tax rates which vary from 15 to 39.6 percent, depending on your bracket. This hasn't changed.

Host : I thought I also heard about a 5-year holding period.

David : Right. This might be called the "super long-term" holding period. In the early negotiations on the tax law there was an effort to index capital gains with inflation. This would have been fair and beneficial, but it would add a lot of complexity to the tax code.

So indexing capital gains for inflation didn't make it into the final law, but as a bone for long-term investors, assets acquired after 2000 face a maximum rate of only 18 percent if held for 5 years or more.

However, this isn't much of a break since assets held for 18 months face a maximum rate of 20 percent.

Host : Still, there's quite a difference in rates between short-term gains and long-term gains.

David : Right, so you'll want to evaluate your holding periods and gains and losses in your various securities near the end of the year. You still can use $3,000 in capital losses to offset $3,000 in ordinary income, so this hasn't changed.

Also, note there's now an even bigger difference between capital gains rates and ordinary income rates. I talk about this in my other audio programs, but you'll want to arrange your holdings inside your tax-sheltered retirement accounts and your assets outside these accounts for diversification and minimum taxation.

Host : Now do these capital gains changes apply equally to all assets?

David : No, and this is another change from the old law. Sales of certain assets like jewelry and fine art aren't eligible for the 20 percent rate. They'll normally face a 28 percent capital gains tax. Also, commercial real estate gains attributable to depreciation and not otherwise recaptured face a 25 percent rate.