Changes to capital gains rules that take place Dec. 31, 2000 will produce automatic savings for some taxpayers, but will require others to pay taxes up front for lower capital gains rates in the future, New York-based RIA said.

Changes to the capital gains rules, enacted as part of the Taxpayer Relief Act of '97, could mean a lower maximum tax rate on qualifying five-year capital gains, RIA reported in its Federal Taxes Weekly Alert newsletter.

"People in higher tax brackets absolutely need to think about these changes since planning will require forecasting five years down the road," said Bob Trinz, an editor for RIA's Federal Taxes Weekly Alert. "It's a good idea for anyone with a capital asset -- whether it be stock, mutual fund, vacation home, investment property -- to begin talking to his or her tax professional about the new rules."

Some of the upcoming changes highlighted by RIA:

For taxpayers in the 15 percent tax bracket, gain from the sale or exchange of capital assets such as stock held more than five years will be taxed at 8 percent, rather than at the 10 percent rate that applies this year.

For taxpayers in a higher tax bracket, the rules are slightly different: Gain from the sale or exchange of capital assets held more than five years will be taxed at 18 percent, as opposed to 20 percent, if they were bought after 2000.

Taxpayers in the 15 percent tax bracket will automatically qualify for a lower rate. However, the 18 percent rate won't be available for gain realized before 2006, because the five-year holding period must begin after 2000 for that rate to apply, RIA said.

If a capital asset held for more than five years is sold by a taxpayer before 2006, the gain on the sale will be taxed at 8 percent to the extent it would otherwise be taxed at a 15 percent rate (if it were ordinary income), and the balance of the gain will be taxed at 20 percent, the firm said.

For taxpayers in the 28 percent bracket or higher, a special election can be taken at the beginning of 2001 for those who already own a capital asset, which will allow them to treat the asset as having been sold on Jan. 2, 2001 for its fair market value on that date, and reacquired on that date for that fair market value. According to RIA, this election helps the taxpayer because it achieves the desired tax results -- assuring that any gain five years down the road won't be taxed higher than 18 percent -- while avoiding sales and purchase commissions. Once made, the deemed-sale-and-repurchase election is irrevocable.

"The deemed-sale-and-repurchase election is a difficult call to make given the many variables involved," Trinz noted. "For example, if you're in a lower tax bracket five years down the road, you might end up prepaying tax at a much higher rate. It's a tricky decision. You'd have to be expecting to sell at a much higher gain to see a benefit."

In sum, taxpayers in a 28 percent or higher tax bracket will need to wait to see a break.  They will need to purchase the asset (or make the special election) after 2000, and hold on to it for five years, RIA said.

-- SmartPros News Staff

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