How do capital gains tax rates work?

New capital gains taxation rates became effective Jan. 1 and can be extremely beneficial to those who take the time to plan accordingly.

Investors in the 15 percent tax bracket will benefit most from the new rate laws, regardless of when capital gains-type assets were bought, said Louis Stanasolovich, founder and president of Pittsburgh-based Legend Financial Advisors Inc. The following chart simplifies the new rules:

Tax bracketRate before Jan. 1, 2001Rate after Jan. 1, 2001Tax savingsTake advantage of "gifting"?Take advantage of "deemed sale"?
15%10%8% (takes effect immediately on all assets regardless of purchase date, but asset must be held for five years20% reductionYesNot applicable
28% and higher20%18% if asset is purchased after Jan. 2, 2001 and held for five succeeding years10% reductionYesYes

Investors in the 28 percent tax bracket and up who have held an asset for more than five years can gift that asset to someone in the 15 percent tax bracket this year, as long as it does not exceed $10,000. The gift recipient can then sell the asset and pay only an 8 percent capital gains tax.

"This strategy would be ideal for gifting to minors who will not be eligible for student aid, and who are attending, or are about to attend, college and/or graduate school or some other type of advanced education," Stanasolovich said. "Another strategy that could apply would be if adult children were supporting parents; they could give appreciated capital gains-type assets to the parents instead of cash."

Unfortunately, those in the 28 percent and higher tax brackets can only take advantage of the lower capital gains rates on assets bought after Jan. 2, 2001. Currently held assets bought before Jan. 1, 2001, will be held to the 20 percent rate—unless a "deemed sale" of assets occurs.

How Does a "Deemed Sale" Work?

A currently owned capital asset could range from a vacation home or readily tradable stocks to any asset that the 20 percent capital gains rate applies to, such as individual bonds. Taxpayers in the 28 percent and higher brackets can effectively sell and repurchase assets without actually selling the asset. They can declare it as sold and then pay the tax owed on it now. It can then effectively be repurchased at the same price for which it was sold (a deemed sale) to begin the required five-year holding period.

"The best assets for deemed sales are securities that have appreciated very little since acquisition," Stanasolovich said. "An investor selling [actually a deemed sale in this case] a tech stock...where that investor has minimal appreciation in the stock now, could benefit [from it] five years from now, assuming of course that the stock appreciates from the date of the deemed sale."

Similarly, he said, "Selling and repurchasing a rental property or primary residence now could result in a lower capital gains tax in five years."

When deciding whether to elect a deemed sale, proceed with caution and discuss your plans with a financial adviser.

Zall, Bureaucratus columnist and a retired federal employee, is a freelance writer based in Silver Spring, Md. He specializes in taxes, investing, business and government workplace issues. He is a certified internal auditor and a registered investment adviser. He can be reached at [email protected].


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