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Looking for another tax break? The ever-changing capital gains tax laws have a recent twist that can qualify you for a super-reduced capital gains tax rate.
Until this new law, there were only two stock holding periods as far as Uncle Sam was concerned. Short-term holdings are those, like most Hollywood marriages, that last one year or less. Long-term holdings are investments you've held for greater than one year. To encourage investors to keep their green in the market for longer periods of time, long-term holdings receive lower capital gains tax rates. But now there's something even better than long-term. It's called super-long-term. First, a quick review.
The long and short of it
The argument for holding investments for greater than one year is pretty convincing. Consider the difference in tax rates for long vs. short:
Short-term holdings sold for a gain are taxed at your normal income tax rate. This year, this is anywhere from 15% for those in the 15% tax bracket, or 28% to 39.6% for those in a tax bracket greater than 15%.
(Bush's new tax plan will bring these rates down to 10% for those in a new 10% bracket, or 25% to 35% for those not in the 10% bracket. These new rates start in the new tax year but are not applicable to 2001. The higher tax rates will gradually decline over many years.)
In contrast to short-term holdings, long-term stock holdings sold for a gain are taxed at a reduced rate. For those in 2001's 15% tax bracket, the rate is 10%. For those in a tax bracket greater than 15%, the rate maxes out at 20%. So, long-term gains: 10% to 20% taxes. Short-term gains: 15% to 39.6%.
You can see how holding on for at least a year can reduce the slice the government carves out by nearly 50%. New rules can reduce that rate even more.
Beginning January 1, 2001, a new super-long-term holding period came into effect. Investments purchased after January 1, 2001 and held for five years or more will be considered super-long-term holdings. (If you're in the 15% tax bracket, any investments held for more than five years qualify for the super-long-term rate, regardless of purchase date.) Investments sold for a gain at a super-long-term holding rate will be taxed at the super-reduced rate of 8% for those in the 15% tax bracket, and 18% for those in tax brackets above 15%.
That's just super. Well, except that little part about needing to buy after January 1, 2001 if you are in a tax bracket above 15%. Any holdings purchased prior to January of 2001 are considered just normal long-term holdings whether you've held them just over a year or 25 years, and whether you sell them in 2006 or in the year 2080, for instance.
The important takeaway
The most important takeaway from the new law is this: Every stock that you purchase after January 1, 2001 is now eligible for the super-long-term holdings tax treatment, giving you even more incentive to purchase great companies that you can hold for at least five years.
For more information on capital gains straight from the horse's mouth, see the IRS publication (Adobe Acrobat .pdf file) on the issue. For understandable information regarding capital gains and losses and many other common tax questions run, don't walk, to the Fool's All About Taxes area.
Keep on Drippin' for the long term.
Vince Hanks is a full-time pharmacist in Michigan and a Drippin' Fool. The Motley Fool is investors writing for investors.