The 1997 tax law introduced a dramatic change in the tax rates for long term capital gains. The maximum tax rate on capital gains was reduced from 28% to 20%. But ... for those in the 15% ordinary income tax bracket, the new rate for capital gains is just 10%.

But the 2003 tax relief act provides even more dramatic changes for investors. The top tax rate on long term capital gains was reduced to 15% for upper bracket taxpayers. For those in the 15% or lower tax brackets, the tax rate on long term capital gains is just 5%.

AND .... the top rate on "qualified" dividend income was also reduced to 15% for upper bracket investors and to 5% for lower bracket investors.

But there is a one way to avoid the capital gains tax entirely. 

You just have to hold onto your appreciated assets for the rest of your life. When you die, your assets will be revalued at their market value at the date of your death or an alternative valuation date six months later. That value then establishes the tax cost (basis) of the asset for your estate or your heirs. If your estate sells the asset, the sales price is likely to be very close to the estate tax value so that there will be little or no gain - or loss. Or, your estate can distribute the appreciated asset to your heirs as part of your bequest to the heirs. When they sell the asset, their tax cost will the same as the value used in the estate. 

Note:  The Tax Relief Act of 2001 introduced some complicated changes in the rules for estate taxes, gift taxes and the step-up-in-basis (tax cost) of assets left at death. The transfer of assets at death with a "stepped-up" tax cost (basis) is scheduled to expire after 2009. However, I believe it is highly unlikely that these rules will remain in the law for very long without substantial revision. 

Special rules apply to jointly held assets and community property. Jointly held property  between a husband and wife is treated as being half owned by each spouse. Thus, one half of the property gets a tax basis equal to the value at the date of death. In community property states, all of the property gets a step-up in basis if it’s held as community property. Where joint owners are not married, and where each party contributed to the purchase of the property, the decedent’s share is based on his or her share of the initial cost. Where one joint owner acquires a joint interest by gift, the entire value of the property is included in the estate of the first joint tenant to die. Thus, if father puts some property into joint ownership with a child, the entire property is included in father’s estate and the child gets the property with a basis equal to the value at the date of death. But if the child had given the property to father within a year of father’s death, the change in basis is not available.

Ideally, the most highly appreciated property would be kept and included in an estate up to the point where the estate is subject to estate taxes. At that point, the estate tax is more costly than the income tax and it would be better to consume any excess assets or to transfer any excess assets by gift. With a well planned estate, a minimum of $1.2 million (going up to $2 million by 2007) can be left free of any estate tax.  These amounts can be easily doubled for a married couple with a relatively simple dual trust arrangement known as a "credit shelter trust". 

Here are some additional tactics to avoid or to reduce the capital gains tax. Links to articles about these other topics are included to the extent that I have written (or updated) articles on those topics.) Some of the topics that are listed are about how to ........

1. Reconstruct the tax cost (basis) of the property to minimize gains 

2. Sell higher cost assets for required cash income 

3. The 50% exclusion on gains from selling stock in a small business that has  been held five years. 

4. Tax free gain on a residence of up to $250,000 per taxpayer. 

5. Give appreciated property to dependents before selling it

6. Give appreciated property to charity instead of cash 

7. Exchange appreciated property for lifetime income from a charitable trust . 

8. Sell non listed property on an installment plan 

9. Give away capital gains in divorce settlements  

10. Give appreciated assets to heirs and consume high basis assets 

11. Use tax deferred exchange for business or investment assets 

12. Use a tax deferred exchange for insurance or annuity products 

13. Sell stock in controlled corporation to an ESOP 

14. Convert appreciated real estate to residential property 

15. Sell appreciated assets to heirs with private annuity

16. Contribute appreciated property to a controlled corporation tax deferred. 

17. Charitable gift and redemption of stock in controlled corporation 

18. The tax deferred roll over of gains on listed securities to a Specialized Small Business Investment Company. 

Caution:  The tax laws are in a constant state of change and my work schedule does not always permit me to revise and update the hundreds of articles on my various web sites with every change in the tax laws. Readers who have a serious interest in minimizing future capital gains taxes should consult with a qualified tax professional before making a sale or entering into any binding agreements such as a letter of intent. 

My report on New Tax Angles for Investors provides a very detailed explanation and analysis of the impact of the 2003 tax law on many of the ideas described or listed in this brief article.

Vern Jacobs
June 25, 2003

Your suggestions for improving this web site are welcome.  Vernon K. Jacobs, Webauthor .