October 2006 News Update

A Reminder Regarding Capital Gains:

In the United States, individuals and corporations pay income tax on the net total of all their capital gains just as they do on other sorts of income, but the tax rate for individuals is lower on "long-term capital gains", which are gains on assets that had been held for over one year before being sold. The tax rate on long-term gains was reduced in 2003 to 15%, or to 5% for individuals in the lowest two income tax brackets. Short-term capital gains are taxed at a higher rate: the ordinary income tax rate. In 2011 these reduced tax rates will "sunset", or revert back to the rates in effect before 2003, which were generally 20%.

The reduced 15% tax rate on eligible dividends and capital gains, previously scheduled to expire in 2008, has been extended through 2010 as a result of the Tax Reconciliation Act signed into law by President Bush on May 17, 2006. As a result:

In 2008, 2009, and 2010, the tax rate on eligible dividends and capital gains is 0% for those in the 10% and 15% income tax brackets.

After 2010, dividends will be taxed at the taxpayer's ordinary income tax rate, regardless of his or her tax bracket.

After 2010, the long-term capital gains tax rate will be 20% (10% for taxpayers in the 15% tax bracket).

After 2010, the qualified five-year 18% capital gains rate (8% for taxpayers in the 15% tax bracket) will be reinstated.

Technically, a "cost basis" is used, rather than the simple purchase price, to determine the taxable amount of the gain. The cost basis is the original purchase price, adjusted for various things including additional improvements or investments, taxes paid on dividends, certain fees, and depreciation.

Exemptions from capital gains taxes (CGT) in the United States include:

An individual can exclude up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. The two years of residency do not have to be continuous. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale. There are allowances and exceptions for military service, disability, partial residence and other reasons. See IRS Publication 523.
If an individual or corporation realizes both capital gains and capital losses in the same year, the losses cancel out the gains in the calculation of taxable gains. For this reason, toward the end of each calendar year, there is a tendency for many investors to sell their investments that have lost value. For individuals, if losses exceed gains in a year, the losses can be claimed as a tax deduction against ordinary income, up to $3,000 per year. Any additional net capital loss can be "carried over" into the next year and again "netted out" against gains for that year. Corporations are permitted to "carry back" capital losses to off-set capital gains from prior years, thus earning a kind of retroactive refund of capital gains taxes.
The IRS allows for individuals to defer capital gains taxes with tax planning strategies such as the charitable trust (CRT), installment sale, private annuity trust, and a 1031 exchange.