How the AMT affects long-term capital gain rates: tax advisers and their clients should be aware of the interaction between the capital gain tax rates and the alternative minimum tax (AMT) when planning for the realization of long-term capital gains (LTCGs). This article examines how the AMT affects the 15% LTCG rate.

• Author: Carslaw, Charles

Tax advisers frequently are asked to estimate the potential effect of large long-term capital gains (LTCGs) on Federal tax. Such gains can occur from the sale of a home, investment properties or securities. Common wisdom is to apply the maximum 15% Federal capital gain rate to the difference between the estimated sale proceeds and the tax basis. Unfortunately, however, the standard 15% estimate is often inaccurate, due to the broadening application of the alternative minimum tax (AMT). This article (1) discusses the AMT's effect on the capital gain structure, (2) provides examples illustrating the problems in relying on the 15% rate and (3) offers guidance to improve the tax liability estimate for large capital gains.

Background

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) (1) amended Sec. 1(h) and lowered the maximum tax rates applicable to LTCGs. For asset sales after May 6, 2003, a 15% maximum rate replaced the old 20% rate under Sec. 1(h)(1)(C). Rates were also reduced in Sec. 1(h)(1)(B) to 5% for taxpayers in the 10% and 15% income tax brackets. Under sunset provisions, these rates will expire for tax years beginning after 2008, and the old rates will apply again.

The JGTRRA LTCG rates are also used to compute a taxpayer's AMT liability under Sec. 55(b)(3). The AMT exemption was increased to $40,250 for unmarried taxpayers, $58,000 for married filing jointly (MFJ) and $29,000 for married taxpayers filing separately. These increases apply to 2003-2005 tax years and will revert to the 2000 amounts ($33,750, $45,000 and $22,500, respectively) for tax years beginning in 2006. (2) The lower LTCG rates and the greater AMT exemptions are generally favorable to taxpayers. However, they may expose certain taxpayers to AMT, because including LTCGs in alternative minimum taxable income (AMTI) can reduce the exemption. This adverse effect can happen with either the new or old AMT exemptions, although it will vary depending on which exemption applies.

How AMT Affects LTCGs

The following examples illustrate the problem for a tax year beginning in 2005 under different filing statuses and various LTCG amounts. The examples use 2005 personal tax rates, standard deductions and personal exemptions.

Example 1--Single filer: S is 55. She is a single filer with no dependents. She has $75,000 salary and $5,000 interest in 2005, giving her adjusted gross income (AGI) of $80,000. S anticipates selling her principal residence, which is fully paid off. The home was purchased in 1992 for $150,000 and, after capital improvements, has a $200,000 adjusted basis. The net sales price of the home is estimated at $750,000. If S were to sell her home in 2005, what would be the estimated Federal income tax cost?

The traditional calculation for the incremental Federal income tax cost is:

Net sales price $750,000 Less: adjusted basis 200,000 Less: Sec. 121 exclusion 250,000 Net capital gain $300,000 Tax at 15% $45,000 The incremental tax on the LTCG is the difference between what S would have paid on her regular income without the LTCG, and the total she will have to pay including it. Her Federal tax without the capital gain would be calculated as follows:

AGI $80,000 Less: personal exemption 3,200 Less: standard deduction 5,000 Taxable income $71,800 Tax $14,615 Adding the LTCG and calculating AMT (assuming no tax preference items) results in the following:

AMT calculation Taxable income $375,000 Addbacks: standard deduction 5,000 personal exemption 0 (phased out) AMTI $380,000 Less: AMT exception 0 (phased out) Less: Capital gain $300,000 AMT base $80,000 Tentative tax (TMT): $20,000 ($80,000 x 0.26) Plus: capital gain tax $45,000 Total TMT 65,800 Less: regular tax $60,000 AMT...