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In the next few weeks, we'll be taking a brief look at some of the key provisions.
Capital Gains Break
Effective for all sales that took place on or after January 1, 1998, the gain on the sale of most capital assets (including stock) held more than one year will qualify for the lowest rates. As you'll remember, before this change, in order to receive the lowest rates, you had to hold the assets for more than 18 months. No longer.
In addition, the 25% rate that applies to certain real property gains will be available for property held for more than one year, rather than more than 18 months. The new law also makes clear (if that is possible) how gains and losses are netted against one another in computing your capital gains.
Roth IRA Changes
Additionally, the new act now permits, effective retroactively to January 1, 1998, those converting their regular IRAs to a Roth IRA in 1998 to pay the resulting tax in only ONE year instead of requiring the "spread out" of the income over a four-year period. In some situations, this will result in a lower overall tax.
As we were also anticipating, there is a "gracious exit" provision in the new act. This provision provides relief for a taxpayer who makes a contribution or a conversion to a Roth IRA and then later finds he was not eligible to make all or part of that contribution because his income exceeded the allowable Adjusted Gross Income (AGI) limitation. The 1998 Act allows him to transfer the excess contribution to a regular IRA without penalty if the transfer is made before the filing due date for his tax return for the contribution year.
Another anticipated change that came to pass in the new act was the repeal of the "restart" of the five-tax year period for Roth IRA conversions. Under the old law, it was important to segregate Roth IRA rollover accounts, since the five tax year holding period applied separately to each individual rollover. But the separate five-tax year holding period for such conversions has now been eliminated by the 1998 Act. Therefore, the five-tax year holding period for Roth IRAs will begin with the year for which a contribution is FIRST made to a Roth IRA. A later conversion will not start the running of a new five-year period.
Finally, the 1998 Act will also allow many additional older taxpayers to convert regular IRAs to Roth IRAs than currently can do so. As you know, you can't convert funds from a regular IRA to a Roth IRA in any year when your AGI exceeds $100,000. For this purpose, your AGI doesn't include income that results from the rollover or conversion, but it DOES include income from taking a required minimum distribution (RMD) from your IRA account. But, starting in 2005, those RMDs will NOT count toward the $100,000 limit. As a result, more taxpayers will have to decide whether or not it is in their best interest to convert to a Roth IRA.
Home Sale Gain Exclusion
For example, John owned and used his personal residence for only one year (out of the required two-year period). He sells his home and realizes a $50,000 gain on the sale. Since John is a single person, his maximum exclusion is $250,000. Under the old law, it was unclear if the excluded amount would be half of the $50,000 gain, or half of the $250,000 exclusion amount. The new law is perfectly clear: the exclusion is half of the total exclusion amount ($125,000 in this example), so none of John's $50,000 would be subject to tax.
Additionally, there was some confusion as to the exclusion for married persons filing jointly. Under the old rules, the tax issues were unclear if one (or both) spouse did not meet the required ownership and use requirements. But the new law says that if the spouses don't meet the requirements for the $500,000 exclusion, the amount of gain eligible for the exclusion is the sum of the amounts to which each spouse would be entitled if they had not been married. This means that if a married couple filing a joint return doesn't qualify for the maximum $500,000 exclusion, the amount of the maximum exclusion that may be claimed by the couple is the sum of each spouse's maximum exclusion determined on a separate basis. This allows the taxpayer to specifically nail down the maximum exclusion when there is a question on the use and ownership requirements.
Finally, for those of you who sold your principal residence ON August 5, 1997, the 1998 Act clarifies that you have the option to treat that sale either under the new rules ($250,000/$500,000 gain exclusion) or under the old "rollover" rules. Before this clarification, the requirements were uncertain for a property that sold and closed directly on August 5.
Next week we'll look at some of the other changes, but remember that this "overview" look is only the tip of the iceberg. If you have any additional questions or comments, please leave 'em in the Tax Strategies message folder and I'll be happy to try and discuss them in greater detail.
-- Roy Lewis
Please note that Roy cannot answer individual questions via e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!
Next: 1998 Tax Changes Part II »
Obviously, the biggest tax-saving change for non-corporate taxpayers is a retroactive reduction in the holding period to qualify for the lowest capital gain tax rate (20% for most people, but 10% if the gain otherwise would be taxed at a 15% rate).
As we had all anticipated, the 1998 Act retroactively closed a loophole that would have allowed taxpayers to spread out the tax on regular-to-Roth IRA conversions while pulling funds out of the Roth IRA without paying the 10% premature distribution penalty.
As anticipated, the 1998 Act clarifies the amount of the reduced exclusion allowed if the taxpayer was unable to meet the two-year ownership and use requirements. The new law specifically states that the reduced exclusion is based on the total exclusion limitation, and not the actual gain on the sale.