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The Tax Prophet Newsletter   Issue # 9 March, 2004

In This Issue:
Capital Gains
Capital Losses
Timing Rules
"Wash-Sale" Trap
Special Dividend Tax Rate
Deducting Investment Interest

The New Investment Tax Rules

Introduction The tax rules regarding investments have undergone major changes. Here are highlights of several significant tax breaks and traps.

Capital Gains

The capital gains rate applies to sales or exchanges of most assets held more than one year. Any gain on inherited property is treated as long-term capital gains regardless of how long the asset is held by either party.

The long-term capital gains rate has dropped from 20% to 15%, but for those in the 10% or 15% tax bracket, the rate is only 5% -- the 5% rate only applies to income, including income from capital gains that remains within the 10% and 15% bracket. The spread between long-term and short-term capital gains rates has also been increased, from 18.6% to 20%; but overall investment considerations should outweigh low capital gains rates.

Capital Losses

If you have capital losses that exceed your capital gains, up to $3,000 of losses can be taken against ordinary income. Since capital losses and capital gains are netted at the end of the year, be careful if you decide to recognize long-term capital gains at the new rate of 15%, you could be losing an opportunity to use a capital loss to offset income taxable at a rate of up to 35%. Capital losses can be carried forward to future years indefinitely and used to off-set short-term or long term capital gains.

Timing Rules

For consideration of the one year holding period, the holding period begins the day after asset acquisition and ends on the date of sale or exchange. The holding period for an asset purchased on June 1, 2003 begins on June 2, 2003 and the long-term holding period is met if a sale of the asset takes place on or after June 2, 2004. When purchasing stock on a public exchange, the holding period starts after execution of the purchase order – the trading date; and ends on the same trading date of the following year.

"Wash Sale" Trap

In general, if a taxpayer sells stock for a loss and then reacquires the same or substantially similar stock within 30 days, the loss is ignored and the transaction is ignored for tax purposes. The investor must wait at least 31 days before repurchasing the same securities in order for the loss to be deductible.

Special Dividend Rate

New tax rates, equal to that for long-term capital gains, apply to certain dividends. Generally, the 15% rate applies to dividends paid from the earnings and profits of (i) a domestic “C” corporation; and (ii) publicly traded foreign corporations listed on U.S. exchanges, provided the taxpayer holds the stock 60 days during a 120-day period that begins 60 days before the dividend is declared.

Dividends that do not qualify for the favored tax treatment include (i) money market and bond funds; (ii) tax exempt entities; (iii) credit unions, savings and cooperative banks and savings institutions; real estate investment trusts; regulated investment companies; retirement plan payments.

Deducting Investment Interest

Investment interest is deductible to the extent of net investment income. Unused deductions may be carried forward, but only if one pays ordinary income tax rates on the investment income received. Thus, to deduct investment interest taxpayers must forego the tax-favored treatment on long-term capital gains and qualified dividends.


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All contents copyright © 1995-2004 Robert L. Sommers, attorney-at-law. All rights reserved. This newsletter provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.