Planning Opportunities for Qualified Five-Year Gain Property

The Taxpayer Relief Act of 1997 created a new category of capital asset. Since its passing, the maximum tax rate imposed on capital gains for assets held more than one year is 20% (10% for gain otherwise subject to the 15% tax bracket). Starting January 1, 2001, the maximum rate drops another 10% on qualified five-year property to 18% (8% for 15% tax bracket taxpayers).

A major difference in the new rates is that the start of the holding period is different: Gain that would be taxed at 10% is taxed at 8% if it is realized on five-year property sold after December 31, 2000.

Gain that would be taxed at 20% is taxed at 18% if realized on five-year property first held after December 31, 2000. Thus, the 18% rate is not available for sales made before January 1, 2006. This makes the break on five-year property unavailable to anyone above the 15% bracket until 2006.

The 8% rate does offer some planning opportunities.

A high bracket taxpayer could transfer long-held assets to a family member in the 15% bracket under the annual gift tax exclusion. For example, parents have stock that they bought 10 years ago for $5,000 and is now worth $20,000. They transfer it immediately to their 13 year old daughter, each using their $10,000 gift tax exclusion. Next year, when the child turns 14 (and no longer subject to the "kiddie" tax) she sells the stock for $22,000. While the parents would have paid $3,400 in tax on the gain, the daughter pays only $1,360 when she sells the stock in 2001.

Taxpayers who have appreciated assets with a holding period of five years or more may want to consider deferring any sale to 2001 when it can be sold by a family member in the 15% bracket.