Capital Gains Rates
From Bankrate.com
Capital gains taxes: There's more than one rate
By Kay Bell • Bankrate.com
Money gurus are always preaching long-term investing. Not only will that give
you a better shot at earning more, it'll also get you a lower tax rate when you
sell.
But exactly what rate you get depends on several things, including when you
bought the asset, when you sold it, your overall income level and sometimes what
tax-code changes are made in the meantime.
Currently, capital gains may be taxed at 5, 15, 25 or 28 percent or a
combination of rates. These tax levels are known as long-term capital gains and
apply to assets that you hold for at least 366 days (more than one year). The
long-term capital gain tax generally is much lower than what you pay on your
regular income.
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In fact, it is a taxpayer's income level that generally determines which capital
gains rate is owed. If your profit pushes you into a higher bracket, you could
possibly be taxed at a combination of rates.
And you could face yet another rate depending upon the type of property you
sell.
Rates cut in May 2003
For many years, investors whose overall income put them in the top four income
tax brackets faced a long-term capital gains rate of 20 percent, while
lower-income investors paid capital gains taxes of 10 percent.
Tax-law changes in May 2003, however, lowered the rates by 5 percent each. Most
investors, which generally means folks in the higher income ranges, now find
their capital gains taxed at 15 percent. But if you don't fit into this
most-common capital gains mold, here's a breakdown of all the tax levels.
Remember, each of these is the long-term capital gains rate. In most cases, that
means you have to hold an asset for more than a year before you sell it. If you
cash it in sooner, you'll be taxed at the short-term rate, which is the same as
your ordinary income tax level and could be as high as 35 percent on 2004
returns.
5 percent rate
This capital gains rate applies to taxpayers in the 10 or 15 percent income tax
brackets. They will pay a maximum 5 percent long-term gains rate on property
held for more than a year.
Lower-income investors get an even better investment sale deal in 2008. That
year, these filers will pay no tax on sales of long-term holdings.
The 5 percent rate still applies to a portion of your gains even if your asset
sale pushes you into a higher bracket. For example, if as a single filer your
taxable income was $25,000 but you netted another $7,000 from a long-term stock
sale, some of that gain would still be taxed at the lower 5 percent capital
gains rate even though technically you were bumped into the 25 percent tax
bracket.
In this case, $29,050 (the income ceiling for the 15 percent bracket) minus your
ordinary income of $25,000 gives you a $4,050 capital gains cushion at the 5
percent level. Only the remaining $2,950 of gain would be taxed at the 15
percent rate applicable to your new, higher tax bracket.
15 percent rate
This most-widely-paid capital gains tax rate applies to long-term investments by
individuals in the 25 percent or higher tax brackets. When you hear "lower
capital gains rate," it generally means this level, because there are few
investors with incomes low enough to qualify solely for the 5 percent rate.
25 percent rate
This rate applies to part of the gain from selling real estate you depreciated.
Basically, this keeps you from getting a double tax break. The Internal Revenue
Service first wants to recapture some of the tax breaks you've been getting via
depreciation throughout the years. You'll have to complete the worksheet on page
7 of the instructions for Schedule D to figure your gain (and tax rate) for this
asset, known as Section 1250 property. More details on this type of holding and
its taxation are available in chapter three of IRS Publication 544, Sales and
other Dispositions of Assets.
28 percent rate
Two categories of capital gains are subject to this rate: small business stock
and collectibles.
If you realized a gain from qualified small business stock that you held more
than five years, you generally can exclude one-half of your gain from income.
The remainder is taxed at a 28 percent rate. If you've already hired a tax
professional to help you sort out the 25 percent rate on depreciable property,
she can help you figure this tax, too. Or you can get the specifics on gains on
qualified small business stock in chapter 4 of IRS Publication 550, Investment
Income and Expenses.
If your gains came from collectibles rather than a business sale, you'll still
pay the 28 percent rate. This includes proceeds from the sale of a work of art,
antiques, gems, stamps, coins, precious metals and even pricey wine or brandy
collections.
Five-year rates disappear … for now
The changes that dropped long-term rates also eliminated (for transactions after
May 5, 2003) two capital gains rates that previously had been in effect.
The 8 percent and 18 percent rates existed for investors who were committed for
the longer haul. Both of these rates, the 8 percent one for taxpayers in the
10-percent and 15-percent income tax brackets and the 18 percent rate for those
in the top four brackets, were applied to assets held for at least five years.
By dropping simple long-term (more than one year) rates even lower, the latest
capital gains changes supersede the five-year rates.
However, depending on future tax legislation, the five-year rates (as well as
the "old" 10 percent and 20 percent long-term categories) might return.
Under the new law, the 5 percent and 15 percent rates are in effect only through
2008. The temporary time frame was included to ensure that the tax cuts didn't
produce too much red ink on the federal budget ledger sheet. On Jan. 1, 2009,
prior law will reappear if lawmakers do not make any further changes.
So what's an investor to do? Since most people will pay less taxes on their
long-term gains thanks to the new laws, financial experts say take advantage of
today's lower rates when they fit into your portfolio plans.
But don't forget about the Dec. 31, 2008, deadline. And definitely keep an eye
on federal tax-law writers in the interim.
-- Updated: Feb. 8, 2005