Five-Year Assets Yield New 18% Capital Gains Rate
New Planning Opportunity

Charles E. Gebhardt, CPA, CVA
Jan 2001

Please note that this paper is a synopsis of tax rule changes and is not intended to be an authoritative guide. Please consult us before relying on anything contained in this paper.

Effective for assets acquired on or after January 1, 2001, a new maximum capital gains rate of 18% applies to capital assts held 5 years or more prior to sale. This represents a 2% advantage over normal long-term capital gains taxed at 20%.

A special rule applies to taxpayers who have acquired assts prior to January 1, 2001 and wish to have the application of the special rule for assets held 5 years apply. An individual may make an election for a "deemed sale" of the asset at its fair market value on January 2, 2001.

Doing so results in the asset being treated as if sold for its fair market value on such date and the asset treated as if it were acquired on January 2, 2001. Having done this, any gain on an asset held 5 years or more from January 2, 2001 will result in a maximum tax rate of 18%.

The law has fixed January 2, 2001 as the date of valuation and deemed sale of a capital asset for which the election is made. Investors should review the assets fair market value on this date to ascertain the current tax cost of making the election.

The election may be made on a selective basis as to blocks of stock acquired on different dates with different cost basis. The investor makes the election as to the securities he/she chooses for the new rule to apply.

Note that stocks that have declined in value from the investor's tax basis to January 2, 2001 will probably not be desirable to make this election since by law, the deemed sale depreciation simply vanishes without any tax benefit available to the investor.

In this case, an actual sale may be appropriate. The investor must mindful, however, in the "wash sales" rule, which holds that no loss may be recognized on securities reacquired within 30 days of having been sold at a loss.

What situations may warrant such election?

With the stock market having reclaimed many of its gains from prior years, investors may find themselves with stocks having little or no appreciation since acquisition. Assuming the investor has long term expectations of growth in the security and thereby plan on holding it in his/her portfolio for 5 years or more, making the election reporting little or no gain will result in the 2% savings in ultimate capital gains tax.

Additionally, individuals with net operating loss or capital loss carryovers may find that making the election with respect to appreciated assets results in no current taxation while qualifying the asset for the special 18% capital gains tax.

When must the election be made?

This is the really good news. Investors will have the benefit of 15 months of hindsight since the deemed sale election does not need to be made until the due date of the 2001 return, or April 15, 2001.

Investors may review the developments in both the market and in their personal portfolio over this period thereby making a better-informed decision. Investors will also have the benefit of knowing the impact of changes in the tax laws, if any that the Bush Administration has been successful in passing into law.