This is the fifth in a series of Alerts Issue 98-1
We interrupted the flow of Alerts dealing with the Taxpayer Relief Act (TRA)
of August 5, 1997 in order to make way for the holiday season. As your thoughts
turn to the preparation of your 1997 tax return, we hope you will agree the
resumption of these Alerts is particularly timely.
Capital Gains Tax Rate Reduction For Individuals and Extension of The
Long-Term Holding Period
General Rules
The new law reduces the maximum rate of tax on an individual's net capital
gain from 28% to 20% (10% for individuals in the 15% tax bracket). However, this
new lower rate of tax applies only to gain attributable to the sale or exchange
of assets held for more than 18 months. Gain attributable to assets held for
more than one year but not more than 18 months will continue to be taxed at a
maximum rate of 28. In addition, this new 20% rate does not apply to certain
real property gains (discussed below), gains from the sale of "qualified small
business stock," or to gains recognized on "collectibles" (such as art, stamps,
coins, etc.).
Examples:
- Stock held for 11 months is sold. The gain is short-term capital gain,
taxable at ordinary income tax rates.
- Stock held for 13 months is sold. The gain is taxed at a maximum rate of
28%.
- Stock held for 19 months is sold. The gain is taxed at a maximum rate of
20%.
These rate changes apply to sales or exchanges of assets (or installment
payments received) after May 6, 1997. However, the 18 month holding period
necessary to qualify for the 20% maximum tax rate does not apply to net capital
gain realized before July 29, 1997.
Example:
- Stock held for 14 months was sold on July 28, 1997. Gain from that sale will
be taxed at a maximum rate of 20%. If the stock had been sold on July 29, 1997
(or before May 7, 1997), the gain would have been taxed at a maximum rate of
28%.
The reduced capital gains rates also apply for purposes of the alternative
minimum tax (AMT). The maximum capital gains rate for corporations remains
unchanged at 35%.
Sales of Depreciable Real Estate
Under previous law, gain from the sale or exchange of depreciable real estate
was generally taxed at ordinary income rates to the extent depreciation taken on
such property exceeded the depreciation that would have been allowed had the
depreciation been computed on a straight-line basis. Under the new law, gain
from the sale or exchange of depreciable real estate not already recaptured
under the preceding rule will be taxed at a maximum rate of 25%.
Sales of Collectibles
Gains from the sale or exchange of a "collectible" (e.g., a work of art, rug,
antique, metal, gem, stamp, or coin) which is a capital asset held for more than
one year, or from the sale of an interest in a partnership, S corporation, or
trust which is attributable to unrealized appreciation in the value of
collectibles, will continue to be taxed at a maximum rate of 28%.
Beyond The Year 2000
Net capital gain from the sale or exchange of capital gain property, the
holding period for which begins after December 31, 2000, and that would
otherwise be taxed at a maximum rate of 20%, will be taxed at a maximum rate of
18%, provided the property was held for more than five years. A taxpayer, other
than a corporation, can elect to treat readily tradable stock (which is a
capital asset) held on January 1, 2001 as having been sold (and reacquired) on
the next day at its closing market price on January 1, in order to benefit from
the lower rates.
Exclusion of Gain From The Sale of A Principal
Residence
Under the new law, a taxpayer may exclude from income up to $250,000
($500,000 for married individuals filing joint returns) of gain from the sale or
exchange of property if the taxpayer owned and used the property as his or her
principal residence for periods aggregating at least two years during the
five-year period ending on the date of the sale or exchange. The exclusion is
available once every two years, and generally applies to sales or exchanges
occurring after May 6, 1997.
This new exclusion replaces prior law provisions under which (i) taxpayers
were able to rollover the gain on a sale of a principal residence if a new
residence at least equal in cost to the sales price of the old residence was
purchased within a two-year period, and (ii) taxpayers at least 55 years of age
were able to exclude, on a one-time basis, up to $125,000 of gain.
Taxpayers may elect to apply prior law to a sale or exchange (i) made before
August 5, 1997 or (ii) made after August 5, 1997 pursuant to a contract that was
binding on such date, or where the replacement residence was acquired on or
before August 5, 1997 (or pursuant to a binding contract in effect on that date)
and the rollover provisions of prior law would otherwise apply.
Note: Taxpayers whose residences have appreciated substantially
(including those who have rolled over gain on the sales of several principal
residences in the past) may find that prior law, which permitted an unlimited
amount of gain to be rolled over, will produce a more favorable result than
under the application of the new exclusion.
Estimated Tax Payments
Filing Threshold For Individuals
The amount of the de minimis threshold for the underpayment of estimated tax
for individuals has been increased from $500 to $1,000. Accordingly, a penalty
for the underpayment of estimated tax will not be imposed where the total tax
liability for the year, reduced by withholdings and estimated tax payments, is
less than $1,000. This change is effective for tax years beginning after
1997.
Estimated Tax Safe Harbor For Individuals
One way an individual with adjusted gross income of more than $150,000 can
avoid a penalty for underpayment of estimated tax is to make quarterly payments
based on his or her tax liability for the prior year. Prior law provided that
such an individual could avoid a penalty for the underpayment of estimated tax
if he or she paid the lesser of 90% of the current year's tax, or 110% of the
tax shown on the return of the individual for the preceding year. The new law
changes the 110% safe harbor to 105% for preceding tax years beginning in 1998,
1999, or 2000; 112% for those beginning in 2001; and reinstates the 110% for
preceding tax years beginning in 2002 or thereafter.
Example:
- Assume a taxpayer has an adjusted gross income of $155,000 in 2001. In order
to use the safe harbor provision to avoid an estimated tax penalty, he would
have to pay the lesser of 90% of his 2001 tax liability, or 105% of his tax
liability in 2000.
The Estate and Income Tax Planning Alert is written
to keep readers current on matters affecting estate and income tax planning and
is not intended to be legal advice. If you have any questions regarding the
information presented: In Pittsburgh call: Edward J.
Greene at 412/566-6021, Fred W. George
at 412/566-5928, Raymond C. Vogliano at 412/566-6994,
Molly E. Few at 412/566-2588, or Mary
Frances Dean at 412/566-1263; and in Harrisburg call:
Norman P. Hetrick at 717/237-6079, Alvin
H. Blitz at 717/237-6027, or Christopher M.
Cicconi at 717/237-6022.
