Capital Gains Rules Revamped

In a last-minute revision to the new tax law, Congress has again changed the rules applying to capital gains--creating separate tax rates for three holding periods.

The change will give a break to investors who would have been penalized by the new law’s lengthening of the capital gains holding period to 18 months from 12 months.

But the revision also will make investment decisions--and record-keeping--more complicated for investors large and small from now on.

Under the tax legislation’s original language, the maximum capital gains tax rate was cut to 20% from 28%, the biggest reduction since 1982.

That compares with a top federal tax rate of 39.6% for ordinary income, such as wages, interest, dividends and investment gains not considered long term.

But in the legislation, Congress also decided to lengthen the required capital gains holding period from 12 months to 18 months. In other words, an asset that previously had to be held just one year to qualify for the capital gains tax rate now must be held for a period half again as long.

The 18-month holding period applies to all qualifying assets sold, beginning Tuesday of this week.

That change, however, socked investors who had been counting on selling assets soon under the old 12-month holding period rule. As the law was written, an asset owned between 12 and 18 months would be subject to the maximum ordinary income tax of 39.6% on any capital gain it generated--far more than the old 28% top capital gains tax rate.

So Republican leaders revised the legislation Wednesday, before it was sent to the full House and Senate for approval.

The new wording keeps the top capital gains tax rate at 28% for assets owned between 12 and 18 months, according to the description of the legislation on the World Wide Web site of House Speaker Newt Gingrich.

“This was done to make sure that taxpayers aren’t worse off under the new law than the old,” said Mark Bloomfield, head of the Washington-based American Council on Capital Formation.

The three top tax rates for investment gains under the revised legislation, for assets sold Tuesday or thereafter:

* 20% if the asset is held at least 18 months.

* 28% if the asset is held between 12 and 18 months.

* 39.6% if the asset is held for less than 12 months.

Meanwhile, for assets sold on or after May 7, but no later than Monday, the capital gains tax rate will be the new low rate of 20% even if the asset was held between 12 and 18 months.

That is because congressional leaders in the spring promised that May 7 would be the effective date of any change in the gains tax.

Capital gains realized before May 7 will be taxed at the 28% top rate.

All of this, of course, will mean that many investors now face a much more complicated task in keeping track of the investments they buy and sell. Mutual fund companies, likewise, will face new tracking and reporting headaches for their capital gains.