Capital Gains
The Henssler Financial Group Position Paper

In 1978, President Carter signed into law a tax package that included a capital gains tax reduction. Congress believed that the tax reduction would encourage additional sales of appreciated assets and the tax revenue from these "unlocked capital gains" would be sufficient to offset much of the revenue loss from the tax cut and possibly lead to an actual revenue increase. Although the decrease in capital gains taxes was intended to stimulate investment activity and increase spending, Congress did not approve of situations where individuals received "too much" of a tax break. So, Congress also imposed an alternative minimum tax on income as adjusted by the capital gains deduction and certain adjusted itemized deductions (but let's save alternative minimum tax for another day's discussion!).

Our current capital gains tax rate structure was enacted in 2005. In general for 2008 to 2010, the capital gains rate of 15% (or 0%, reserved for those in the lowest income tax bracket) applies to the sale of capital assets held long term. A capital asset is generally any property except for:

Special rates also apply for collectibles and depreciation recapture (again, another day's topic).

To qualify for long-term capital gain treatment, assets must be held for at least a year and one day before being sold. For stocks, it is the trade date that counts, not the settlement date; and for other assets, the day that the ownership changes, and not the contract date, for example, determines the date of sale. If the asset is held for less than 12 months, then the gain is considered short term and taxed at ordinary income tax rates at whatever tax bracket the taxpayer is in that particular year. In the case of gifts or property received in a divorce, the holding period "carries forward" from the original holding period of the previous owner. Additional rules also apply when business assets are distributed to owners or partners.

For taxable years 2008 through 2010, any gain from the sale or exchange of property held more than five years, which would normally be taxed at the 10% rate, will be taxed at a 0% rate. The same applies for any gain from the sale or exchange of property held more than five years that would normally be taxed at the 20% rate, as it is taxed at a 15% rate. In 2011, these rates will revert to the pre-2001 rates.

We all know that generally a gain or loss is not recognized on our tax return until we sell or dispose of an asset. A "paper loss" — a drop in an investment's value below its purchase price — does not qualify for this deduction. The loss must be realized through the asset's sale or exchange. Upon disposal of an asset, any gain is included in our taxable income. The net capital gain is calculated as the difference between the net sales price and the original cost, or basis. If the asset is sold below our cost, the difference is a capital loss. Capital losses are first used to offset capital gains, but any excess can be used to offset ordinary income up to $3,000 per year, and any remaining capital losses are carried forward to the next tax year. Determining the holding period makes the greatest difference whether an asset is entitled to short-term or long-term capital gain treatment.

Times have changed since 1921 when the maximum tax on capital gains was 12.5%. Present law provides different tax rates for different types of property with rules provided by a complex tax code, complicating our financial planning and tax planning, and requiring more detailed record keeping by taxpayers. And believe it or not, it's not all a scam to force you to support your local C.P.A. Seriously, consult your tax adviser or financial planner. Capital gains can have a serious impact on your tax situation. It's very important to plan ahead!

If you would like any further information regarding this issue as well as any other tax related issue, please contact The Henssler Financial Group Tax & Accounting Division at 770-428-4025.