New Capital Gains Tax Rates Effective 1/1/01
The capital gain tax rates are due to be decreased effective January 1, 2001, but only taxpayers with stock that has been held for more than five years will be affected by the change.
Capital gains are profits on the sale of items held for investment, such as stocks, bonds, household furnishings, vehicles used for personal purposes, and real estate (although if the real estate you sell is your personal residence, the gain may not be subject to tax). Special rules apply to gains on the sale of certain items that are considered to be collectibles. See the description of the special rate for collectibles later in this column.
You determine the profit on an investment item by deducting the cost (increased by the cost of improvements you have made to the investment) from the sales price (decreased by costs of the sale, such as a sales commission). This calculation is made when you fill out Schedule D on your tax return.
For tax returns for the year 2000, the maximum tax on capital gains on sales of investment items owned more than one year is 20%. You may pay personal income tax of as high as 39.6% on your regular income, but the tax that is calculated on your capital gain income will not exceed 20%.
Some people only pay a maximum income tax rate of 15% on their regular income. For these people, the maximum capital gain tax rate is 10%. For the year 2000, people who pay a maximum tax rate of 15% (and for whom the capital gain tax rate is 10%) are those whose income is below these amounts:
To use the capital gain tax rate, you must have owned the investment for more than one year, and you must compute the tax on the capital gain portion of your income on Schedule D, which gets attached to your tax return.
Starting January 1, 2001, investments that have been owned for more than five years will receive a special, lower capital gain tax rate of 18%. For someone who had $10,000 in capital gain on his tax return for investments owned more than five years, this new rule represents a tax savings of $200.
Taxpayers who pay income tax at the lower, 15% tax rate, will also benefit from the new law. The maximum 10% capital gain tax rate for these taxpayers is reduced to 8% on the gain on the sale of investments owned for more than five years. Again, this represents a $200 tax savings on $10,000 worth of gain.
Rule Not as Easy as it Sounds
The catch in the new rule is that, if your tax bracket is higher than 15%, the stock (or other asset) must be acquired after December 31, 2000, in order for the 5-year, 18% rate to apply. Taxpayers who pay no more than 15% tax on their regular income can start taking advantage of this rule immediately, no matter when they acquired their stock (or other asset), as long as they have owned it for five years.
A bizarre quirk in the rule will let taxpayers who acquired stock (or other capital assets) prior to 1/1/01 use the 5-year/18% rule on sales, if they commit to changing the purchase date, for record-keeping purposes, to 1/1/00, and then hold the asset for at least five years. This election must be made in 2001, and any gain that would have occurred if you actually sold the stock or other asset on 1/1/01, must be reported on your 2001 tax return. If a sale of the asset on 1/1/01 would have resulted in a loss, there is no tax benefit available for the loss.
For 15% Taxpayers
If you are a 15% taxpayer and have owned your investments more than five years (or will have done so in 2001), figure out how much gain you will have, then multiply the gain by 2% to determine how much tax money you will save under the new rules. Make your decision about when to sell based not only on the amount of tax you will save on the sale, but by including other important factors, such as the rate of regular income tax you will pay in both 2000 and 2001, the amount of capital losses you might have to offset the capital gain in either year, your current cash flow needs, and how you expect the investment to perform in the next year.
And while you're thinking about year-end tax planning, be sure to check out our Quick Tips for Year-End Tax Savings.
Special Rate for Collectibles
The IRS applies a special tax rate to items that are classified as collectibles. This category includes works of art, rugs, antiques, metals including gold, silver and platinum bullion, gems, stamps, coins, and alcoholic beverages (that collector bottle of Elvis Presley wine, for example!).
The gain on these items qualifies for a tax rate of 28%. This of course is only advantageous when your regular income tax rate is higher than 28%. If your regular income tax rate is 15%, the tax on sales of collectibles is 15% as well.