This coming January officially marks the three-year countdown before the axe falls on the lower individual capital gains rates now in place. Since May 6, 2003, thanks to the Jobs and Growth Tax Relief Reconciliation Act of 2003, gain from the sale of most long-term capital assets is subject to a maximum tax rate of 15 percent (5 percent for individuals in the 10 percent or 15 percent tax bracket). Starting in 2011, however, these rates are scheduled to revert to their former pre-May 6, 2003, levels of 20 percent and 10 percent, respectively. Nevertheless, before the party ends, a 0 percent rate will replace the 5 percent rate for tax years beginning after Dec. 31, 2007.
Unfortunately, not all capital gain shares in this dramatic tax reduction: gain on collectibles remains subject to a maximum rate of 28 percent, and unrecaptured Section 1250 gain continues to be subject to a maximum rate of 25 percent, both now and after 2010. The majority of capital gains subject to tax, however, are included in the favorable, but still officially temporary, rate reduction.
Several GOP lawmakers recently emphasized how lower tax rates on capital gains and dividends have generated an increase in tax receipts, as well as sustained economic growth. While precise measurement of the impact of lower capital gains may be difficult, so is an accurate prediction of the future impact of allowing the maximum capital gain rate to revert to a 20 percent rate after 2010.
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What is certain, however, is that taxpayers with long-term capital gains clearly won't benefit, at least in the short run. With this reality in mind, it may not be too early to start lining up some tax strategies to help soften the blow.
FIVE-YEAR PROPERTY
Prior to the 2003 general reduction of the maximum capital gains rates to current levels, one tax benefit that had been gaining momentum was the reduced rates for "five-year property." Under that scheme, which had been effective since 2001, any gain from the sale or exchange of property held for more than five years that would otherwise be taxed at the then-10 percent rate was taxed at an 8 percent rate. Any gain from the sale or exchange of property held more than five years and after Dec. 31, 2000, and otherwise taxed at the then-20 percent rate, would be taxed at an 18 percent rate.
This favorable treatment for five-year property was first sidelined by the 2003 act, when the general capital gain rate was lowered to the maximum 15 percent rate subject to sunset after 2008. The Tax Increase Prevention and Reconciliation Act of 2005 then extended the sunset for two more years, to 2010.
This sunset, rather than repeal, of the five-year property rate, however, means that five-year property suddenly is again relevant. Any capital asset purchased on Dec. 31, 2005, for example, will be entitled to an 18 percent rate if sold after Dec. 31, 2010, and if Congress makes no further changes. While the two-percentage-point rate differential between a maximum 18 and 20 percent rate may not control a sell-or-hold decision now, the closer one gets to 2011 and a five-year holding period, the more relevant the five-year property "discount" on the capital gain rate will become.
