- The Tax Genie
Capital Gain Rules
By Sidney Kess
THE TAXPAYER RELIEF Act of 1997,
signed into law on Aug. 5, made important changes in the rules
for capital gains. Now, different tax rates apply, depending on
when the asset was sold, how long it was held and its nature.
- The maximum tax rate on capital gains dropped to
20 percent (down from 28 percent) for sales on or after
May 7, 1997, of property held more
than one year.
For those in the 15 percent tax bracket, the rate was
reduced to 10 percent. However, for sales of assets after
July 28, 1997, assets must be held more
than 18 months
to qualify for the reduced rate. Assets sold after July
28, 1997, and held more than one year but not more than
18 months are subject to the maximum 28 percent tax rate.
Assets held one year or less and sold at any time are
still treated as short-term capital gains taxed at the
same rate as ordinary income. The reduced capital gains
tax rates apply not only to individuals but also to
trusts and estates.
- After 2000, in addition to the reduced tax rates
above, an even lower rate of 18 percent (8 percent for
those in the 15 percent tax bracket) applies to property
held for more than five years. The five-year holding
period starts after 2000 for those in tax brackets higher
than the 15 percent bracket (those in the 15 percent
bracket can begin the five-year holding period at any
time). There is a special election allowing individuals
in higher tax brackets to elect to treat assets acquired
before 2001 as having been acquired after 2000. Making
this election requires immediate recognition of gain to
date. Unless an individual has capital losses that will
offset the gains, the potential 2 percent tax rate
savings may not be worth the current income tax cost.
Special Rates for
The reduced capital gains rates do not apply to
collectibles (e.g., stamps, antiques, gems, and most
coins). Gain from the sale of collectibles held more than
one year is taxed at no more than 28 percent.
real property. Gain on
depreciable real property sold on or after May 7, 1997,
is subject to a special rate on the portion of the gain
related to depreciation recapture. Such gain is taxed at
a 25 percent tax rate; the balance is eligible for the 20
percent rate. If a building costing $200,000 was fully
depreciated over 15 years when it is sold on Dec. 1,
1997, for $1 million, of the $1 million gain (there is no
basis in view of the depreciation), $200,000 is taxed at
25 percent and $800,000 is taxed at 20 percent.
- The depreciation recapture rule applies to sales
of homes that were used partly for business. So, for
example, if an individual has claimed a home office
deduction, the portion of the gain from the sale of a
residence representing depreciation claimed on the office
is taxed at 25 percent.
small business stock. Gain on
the sale of small business stock held more than five
years is still 50 percent excludable. However, the
nonexcludable portion is not
subject to the 20 percent rate. Instead, it is taxed at
the maximum 28 percent rate (which results in an
effective tax ate of 14 percent-50 percent of 28
percent). If the stock is not held for more than five
years, (but is held for more than 18 months), no
exclusion can be taken but the gain is eligible for the
20 percent rate.
- There is an opportunity to defer all
gain recognition on the sale of small business stock by
rolling over the proceeds into other small business
stock. The rollover must take place within 60 days of the
date of sale. Only small business stock held more
than six months
is eligible for this rollover treatment.
- Most homeowners need no longer worry about taxes
when selling their homes. The new law simplifies the home
sale rules and provides meaningful tax relief for homes
sold on or after May 7, 1997. It allows individuals to
"trade down" without adverse tax consequences
and may simplify record keeping of home improvements for
- The old rule allowing gain to be deferred if a
replacement home was bought or built within two years
before or after the date of sale and the $125,000
once-in-a-lifetime exclusion for those age 55 and older
have been repealed. In their place is an exclusion of
$250,000 ($500,000 on a joint return) for the sale of a
principal residence by a seller who owned and occupied
the home for at least two of the preceding five years. On
a joint return, title to the home need not be in joint
name as long as both spouses lived in the home for at
least two years and neither claimed an exclusion within
the past two years. In effect, this exclusion can be used
any number of times as long as the two-year requirement
is satisfied each time.
- Use of the new exclusion is not affected by
whether a homeowner previously claimed the $125,000
- The two-year rule is waived if a move is
necessitated by a change in jobs or some unforeseen
circumstances. In this case, a prorated exclusion is
allowed for the period of the two-year period that has
been satisfied. So, for example, if a single individual
relocates to a new job after owning and living in a house
for one year, the exclusion is $125,000 (one-half of
$250,000). The two-year rule is reduced to a one-year
requirement if the move is required because the owner
becomes physically or mentally incapable of self-care and
moves to a licensed nursing home. In this case, as long
as the one-year requirement is satisfied, the full
exclusion can be claimed.
marital status. A spouse who
received the marital residence in a transfer incident to
divorce can add on the former spouse's ownership period
for purposes of the two-year requirement. Similarly,
widowed individuals can include the ownership period of
the deceased spouse for purposes of the two-year period.
- Individuals who own separate homes and marry do
need not to time the sale of their homes to before or
after the marriage. As long as they meet the two-year
requirement, they can each claim $250,000 exclusion on a
joint return (a total of $500,000).
rule. Those who were in the
process of selling their homes when the new law was
enacted have a choice between the old or new rules if:
- The sale was completed before Aug.
- The sale was completed after Aug.
5, 1997, pursuant to a binding contract in effect
on that date, or
- A replacement residence was
acquired on or before Aug. 5, 1997 (and the
deferral rules apply).