Diverse planning opportunities available under the TRA '97.

• Author: Bukofsky, Ward M.
• Position: Part 1 - Taxpayer Relief Act of 1997

The Taxpayer Relief Act of of 997 undoubtedly contains some extremely complex provisions, including myriad capital gains rates and holding periods and gyrating estimated tax payment percentage requirements. But there is some good news--larger gain exclusion on the sale of home, c' child tax credit, and liberalized home office and self-employed heath insurance deductions. This two-part article explains the planning possibilities for individuals.

The Taxpayer Relief Act of 1997 (TRA '97), enacted Aug. 5, 1997, contains many provisions affecting individuals. Despite Washington's rhetoric about the need to simplify the Code, this legislation is undoubtedly the most complex since 1986. The first part of this two-part article explains the various new provisions and planning opportunities in the areas of investments, personal residence, child tax credit, and miscellaneous. Part II, in the February issue, will cover the TRAM '97's education and retirement incentives.

Investments

Reduced Maximum Capital Gains Rate

Under TRAM '97 Section 311 (a), amending Sec. 1(h), the maximum capital gains rate (for both regular and alternative minimum tax (AMT) purposes) is decreased from 28% to 20% for assets sold after July 28,1997 and held for more than 18 months. There are a number of exceptions to this general rule.

For taxpayers in the 15% bracket, the maximum capital gains rate is reduced to 10%. The 20% rate also applies to property held for more than a year that was sold after May 6, 1997 and before July 29, 1997. The prior-law maximum, 28% rate continues to apply to the sale or exchange of capital assets after duly 28, 1997 held for more than one year but not more than 18 months, as well as to the sale of collectibles (e.g., artwork, jewelry) held for more than one year (even if held for more than 18 months).

For property acquired after 2000 and held for more than five years, the maximum capital gains rate drops to 18% (8% for those in the 15% bracket). Under TRA '97 Section 311 (e), a taxpayer can mark-to-market in 2001 property acquired before that year (and expected to be held at least five years) to allow the future appreciation to be taxed at 18%.

In addition, a new 25% rate applies to the portion of gain attributable to Sec. 1250 straight-line depreciation previously claimed on real property;

Example 1: A commercial building was purchased for $100,000; after $20,000 of depreciation was taken,it was sold for $150,000. The gain is $70,000 ($150,000 proceeds - $80,000 adjusted basis); $50,000 would be taxed at the 20% rate and $20,000 at the 25% rate.

A Treasury official has confirmed that the pre-TRA '97 Sec. 1250 ordinary income recognition rule for accelerated depreciation in excess of straight-line on real property remains in effect; the portion of any gain attributable to depreciation in excess of straight-line is recognized at ordinary income rates.

The issuance of 1997 Form 1040, Schedule D, Capital Gains and Losses, indicates that the 28% rate applies to the receipt of certain installment payments. Specifically, the 28% rate applies to installment payments received either (1) before May 7, 1997; or (2) after July 28, 1997 for assets held for more than one year but not more than 18 months. The 20% rate applies to installment payments received after May 7,19'37, if the holding period was 18 months or more (for sales occurring after May 6, 1997 and before duly 29, 1997, if the holding period was at least 12 months).

These rules also apply to an individual's share of gains reported by passthrough entities; the holding period is determined at the entity level.

Treasury and Joint Committee on Taxation officials have verbally indicated that the treatment of installment sales of depreciable real property is still being considered. One possibility is to recognize depreciation recapture (at the 25% rate) on a pro rata basis as installment payments are received; alternatively, depreciation recapture could be recognized first, before any 20% rate gain is recognized. In either case, the original sale will determine the total depreciation recapture required. The table on page 21 summarizes the various rates applicable to capital gains.

Planning opportunities: With the reduction in long-term capital gains rates, there is now more incentive to pursue investment strategies that emphasize capital appreciation over current income for accounts that are not tax-deferred.

The alternatives must be analyzed carefully to determine whether it is better to hold growth-oriented investments, inside or outside tax-deferred accounts. Despite the lower rates applicable to long-term capital gains, it may still be better to hold such investments inside tax-deferred accounts (e.g., individual retirement accounts), depending on, for example, the investment return assumed, the frequency of portfolio turnover, the taxpayer's age, etc.

To take advantage of the 10% and 20% rates, shares of securities and/or mutual funds held more than 18 months generally should be specifically identified (in writing) by the taxpayer prior to executing the...