New capital gains rate rules could provide savings for tax-savvy investors
By Kay Bell • Bankrate.com

There's a lot to consider when it comes to deciding whether the new, lower capital gains rates and options for taking advantage of them are right for you. But don't panic. You've got time to figure out just how they affect your tax situation.

The decision to elect to pay tax on a holding in order to make it eventually eligible for the lower capital gains rate doesn't have to be made until you file your 2001 taxes. That could be as late as Oct. 15, 2002, if you take maximum advantage of the tax return extensions allowed.

This long-range filing timetable also offers taxpayers the benefit of tax hindsight when it comes to the new capital gains rates and options, notes Robert Trinz of RIA, a tax information and technology company. By letting stock holdings play out for more than a year, some investors may be able to take advantage of the mechanics of the new rates even if they don't actually get the lower rates themselves.

New rate rules offer tax choices
In fact, some of these savvy taxpayers may be able to spread out taxable gains over two years and reduce their overall tax bill even though they'll still be paying at the current 20 percent rate. Here, according to RIA's Federal Taxes Weekly Alert, is how it could work:

Ted Smith bought 1,000 shares of stock several years ago at $10 a share. On Jan. 2, 2001, its closing value is $20. Ted plans to sell the stock in 2002 if it reaches his target price of $30 a share.

In this scenario, all of Ted's eventual $20,000 gain would be included in 2002, be taxed at 20 percent and push him into a higher overall tax bracket that year that could cause other tax problems (for example, phase-outs of deductions based on adjusted gross income).

Instead, recommend RIA analysts, Ted should consider using the deemed sale option under the new capital gains rules. This way, Ted "sells" his stock at double the price on Jan. 2, 2001, and immediately "repurchases" it. Of course he still pays the 20 percent rate on this act, but only on a gain at that time of $10,000 and for tax year 2001.

When he actually sells the stock at his target price in 2002, he again will be taxed at the 20 percent rate (because it didn't meet the five-year holding period necessary for the 18 percent rate). However, since he changed his purchase price from $10 to $20 in 2001 with the deemed sale move, Ted now will have only a gain of $10,000 due on his 2002 taxes.

So instead of paying taxes in a single tax year on $20,000 in capital gains, Ted meets his investment target and spreads out his tax bill over two years.

No decision needed until 2002
Because he doesn't have to declare a deemed stock sale until he files his 2001 tax return in 2002 -- in April or August or October with extensions -- Ted has time to gauge the effect of his election on his overall tax picture.

The Internal Revenue Service will even give taxpayers who file in April 2002 a chance to change their minds if they decide they should have "sold" their stock holdings under the new rules. All they have to do is file an amended return by Oct. 15, 2002. Once the deemed sale election is made, however, it's irrevocable.

-- Posted Dec. 13, 2000