1. What are the current long-term capital gains tax rates?
Zero percent for taxpayers in the 10% and 15% tax brackets in 2017. In 2021, with respect to adjusted net capital gain, the 0% rate will apply to joint filers who earn less than $80,800 (half the amount for married taxpayers filing separately), heads of households who earn less than $54,100, single filers who earn less than $40,400, and trusts and estates with less than $2,700 in income. See here or here for rates for other tax brackets.
2. How is net capital gain taxed?
Net capital gain is the excess of net long-term capital gain for the taxable year over net short-term capital loss for such year. However, net capital gain for any taxable year is reduced (but not below zero) by any amount the taxpayer takes into account under the investment income exception to the investment interest deduction.
3. What rates apply to gains on the sale or exchange of capital gains property classified as Section 1250 property, Section 1202 stock or collectibles?
Gain attributable to the sale or exchange of collectibles, IRC Section 1202 gain (i.e., qualified small business stock), and unrecaptured IRC Section 1250 gain are subject to different tax rates. Gain on the sale or exchange of collectibles and IRC Section 1202 property is taxed at 28%, and unrecaptured gain on IRC Section 1250 property is taxed at 25%.
4. What new rules have been developed in recent years to change the tax rates on long-term capital gains?
Long-term capital gains recognized on or after May 6, 2003 are subject to lower tax rates today than has historically been the case. Under the 2017 tax reform legislation, those lower rates continue to apply, but the income thresholds that determine to whom those rates will apply have changed along with the changes to the individual income tax rates.
Up until 2018, for taxpayers in the 25%, 28%, 33% and 35% ordinary income tax brackets, the rate on long-term capital gains was reduced from 20% to 15% in 2003 through 2012. For taxpayers in the 10% and 15% brackets, the rate on long-term capital gains was reduced from 10% to 5% in 2003 through 2007, and then to 0% in 2008 through 2012.
5. What is “tax basis” and how is it used?
“Tax basis” is a taxpayer’s after-tax investment in property. In other words, when a taxpayer acquires property for money, the purchase price is presumed to be his or her after-tax investment in such property. When property is sold or exchanged, for purposes of computing gain, the difference between the amount received less the taxpayer’s basis in the property is the taxable gain. Similarly, for purposes of computing a loss (meaning the taxpayer received less than the original cost of the property), the difference between the taxpayer’s basis in the property and the amount received is the taxable loss.
6. How is tax basis adjusted and how does it impact the computation of capital gain or loss?
Capital gain or loss is measured by determining whether the amount received in a sale or exchange of property was more or less than the taxpayer’s “basis.” If the amount received is more than basis, there is a taxable gain. Conversely, if basis is greater than the amount received there is a loss. However, during the period of a taxpayer’s ownership of property, certain adjustments to the original tax basis are required. Thus, tax basis, as adjusted, is referred to as “adjusted basis.”
Examples of adjustments are capital improvements and depreciation.
7. What is the deduction for depreciation?
Depreciation is a deduction that permits recovery, over a period of time, of capital invested in tangible property used in a trade or business or held for the production of income. It is a deduction taken in arriving at adjusted gross income.
Only property that has a limited useful life may be depreciated. Land does not have a limited life and, therefore, cannot be depreciated. However, the improvements on land can be depreciated. Inventory and stock in trade are not depreciable. A taxpayer who purchases a term interest in property cannot amortize or depreciate the cost of the property during any period in which the remainder interest is held by a related person. On the other hand, life tenants and beneficiaries of estates and trusts may be allowed the regular depreciation deduction if the property is depreciable property.
8. What is the unit of production method of depreciation?
Instead of using ACRS, a property owner may elect to use the unit of production method of depreciation (if appropriate) or any other method not expressed in a term of years. For example, under the unit of production method, the depreciation deduction for a machine that, it is estimated, will produce 1 million shoes (units) before wearing out, and that produces 250,000 units in the first year, would be:
(250,000 ÷ 1,000,000) × basis.
9. Is there any relief for taxpayers who failed to make elections with respect to bonus depreciation for 2016 or 2017 because of the timing of the new tax reform law?
Yes. Some taxpayers expressed concern that the tax reform legislation’s changes to the bonus depreciation rules came too late for taxpayers to make the relevant elections on their 2016 or 2017 tax returns. In response, the IRS released guidance permitting taxpayers to revoke an election, or make a late election, for bonus depreciation with respect to certain property acquired by the taxpayer after Sept. 27, 2017 and placed into service (or planted) during the tax year that included Sept. 28, 2017.
10. How is the depreciation deduction determined for partners in a partnership?
The 2019 proposed bonus depreciation regulations provided a “look-through” rule under which a partner was considered to have a depreciable interest in a portion of property equal to the partner’s total share of depreciation deductions during the current calendar year and previous five calendar years. This rule limited bonus depreciation in many situations involving partnerships transactions.
The 2020 final regulations rescinded this rule because of administrative and compliance burdens both for taxpayers and the IRS. Under the new rules, partners are not treated as having a prior depreciable interest in property solely because of membership in a partnership. Rather than simply replacing the rule, the IRS pointed to the series of related transaction rules that apply to prevent abuse.
11. What about short sales?
Whether capital gain or loss on a short sale is long-term or short-term will ordinarily be determined by the seller’s holding period in the stock used to close the sale. For most purposes, the capital gain or loss is long-term if the holding period is more than one year. If the holding period is one year or less, the gain is short-term.
In a “short sale,” a seller agrees to sell stock to another at a fixed price on a future date. If the future date is more than a year from the date the taxpayer acquired the stock, he or she would be able to convert short-term capital gain (taxed at ordinary tax rates, i.e., up to 39.6%) to long-term capital gain (i.e., with rates of 0%, 15% or 20%). IRC Sections 1233 and 1259 are designed to prevent such abuse.
12. Can the redemption of a debt obligation result in capital gains treatment?
Redemption of a debt obligation can result in recognition of gain or loss in situations where the obligation was acquired at a premium or discount. The relevant issue for determining whether the retirement or satisfaction of the debt can result in a capital gain or loss is whether a sale or exchange has taken place. Historically, cases dealing with the subject have found that no sale or exchange takes place when the maker of a debt satisfies the obligations under the debt instrument. IRC Section 1271 was enacted to change this result in many situations involving the redemption of debt obligations.
13. What about sale or exchange of an option to purchase property?
The sale or exchange of an option to purchase property may result in capital gain if the underlying property subject to the option is a capital asset. Similarly, losses arising from the taxpayer’s failure to exercise the option may be treated as capital losses if the underlying property is a capital asset.
Similarly, if the taxpayer fails to exercise the option, the option is treated as though it was sold or exchanged on the day the option expired for no consideration. Based on the taxpayer’s holding period, the loss will be either long-term or short-term capital loss.
14. Are there any special rules that apply in determining whether the sale of a patent gives rise to capital gains treatment?
Unlike typical asset sales, if the sale or exchange of a patent meets certain requirements, the sale will automatically qualify for long-term capital gains treatment regardless of the transferor’s holding period and whether or not the patent would have been classified as a capital asset in the hands of the holder who transfers the patent.
Sale of a patent will qualify for long-term capital gains treatment if the holder of the patent transfers either “all substantial rights” in the patent or an undivided interest in the patent.
15. What is the tax significance of short-term capital gain?
Like long-term capital gain, short-term capital gain is netted against capital losses, net short-term capital gain is not subject to the preferential capital gains rates. Instead, such gain is taxed as ordinary income (up to 39.6%).
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November 11, 2021 at 03:19 PM
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