Lower rates, shorter holding period

For taxpayers in the 28% or higher bracket, the maximum tax rate is now 20% on gains from capital assets, such as stocks and bonds, that are held more than 12 months. Taxpayers in the 15% bracket now pay 10% on these gains. These rates also apply to real estate gains, except that recaptured depreciation is generally taxed at 25%. The maximum rate for collectibles, such as coins and antiques, held over one year is 28%.

Planning can increase return

What should the savvy investor do to maximize after-tax returns? That depends, since many factors other than taxes affect investment decisions. However, careful planning can make a significant difference in your investment return.

Collectibles are generally less appealing than other investments. Bonds are also less attractive, because they usually produce more ordinary income than capital gains. For the same reason, high-dividend stocks are less desirable than low-dividend stocks. Mutual funds that make minimal dividend distributions are also relatively more appealing.

If you have children in the 15% tax bracket, you may want to consider gifting appreciated stock to them. They can then sell the stock and pay as little as one-half the taxes you would pay. (Watch out for the kiddie tax, however.)

If your employer offers stock options, be sure to manage their exercise and sale to maximize your long-term capital gains.

You pay ordinary tax rates on taxable distributions from your retirement accounts, regardless of how much capital gains income they contain. Therefore, you may want to evaluate the assets in these accounts in relation to your nonretirement investments. For example, the closer you are to retirement, or the higher you expect your retirement tax rate to be, the more you may benefit from keeping assets with long-term gain potential out of your retirement accounts.

Be careful with capital losses. The timing and size of your capital gains and losses could affect whether you achieve maximum tax benefit from your losses.

Be aware that the exercise of substantial incentive stock options can trigger the alternative minimum tax, with all its related complications.

With the big gap between long-term capital gain and ordinary tax rates, good recordkeeping is very important to ensure capital gains treatment. Also, when determining if you've met the required long-term holding period, remember that your holding period starts the day after you purchase an asset and includes the sale date.

Note: Effective January 1, 2001, the 20% capital gains rate dropped to18% for assets purchased after December 31, 2000, and held for more than five years. For lowest bracket taxpayers, the 10% rate dropped to 8% for assets sold after December 31, 2000, and held for more than five years.

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