New Law for Capital Gains

NEW LAW FOR CAPITAL GAINS DEEMED SALE

Thanks to a 1997 law that finally goes into effect January 1, 2001, taxpayers will see a reduction in the capital gains rate for long-term holdings of certain assets.  Even though the new rate will only decline by 2 percentage points, it is possible to work the law to your advantage and save considerably more than 2%.

This law will be beneficial in the right set of circumstances, but the law is complex and will require your accountant to work through the tax rules.

The law will change capital gains tax rates if you are in the 15% marginal federal income tax bracket from a capital gains rate of 10% down to 8% if you have held a “qualifying asset” for at least five years.  If you are in a higher tax bracket and thus paying 20% capital gains, the rate will be lowered to 18%, but this will only occur if you purchased the asset after December 31, 2000, and then hold it for five years.

Now for the tricky part.  If you have an asset, such as a residence that you have lived in for two of the last five years, you can make a special election in 2001 known as a “deemed sale and repurchase election.” This election pretends that you sold the home January 1, 2001.

This works because each person gets to exclude up to $250,000 in profit on the sale of a personal residence.  This allows you not to have to pay any tax today due to the exemption even though you’ve made a “deemed sale.”  If you know you are going to live in the house at last two more years, you may be able to exclude another 250,000 per person when you do sell the house.  This all happened because the “deemed sale” is considered a real sale for tax purposes, thus qualifying you for the residential real estate tax exclusion.

Because you can exclude up to 250,000 per person (500,000 per couple) on the sale of your personal residence every two years, “deemed selling” a highly appreciated home for tax purposes at least two years before you actually sell it could effectively allow you to exclude up to 500,000 in profit per person or 1,000,000 for a couple.

If you are unsure whether you are going to live in the house for two years, the IRS has sweetened the pot by allowing you to send the notice of the “deemed sale” election at the time you file your next annual tax return.

This means that most people will have till April 15, 2002 to let the IRS know what they did on January 1, 2001.  And if you are still unsure, with the various extensions, you can actually stretch your decision-making process out through October 15, 2002.