Re: Holding Period for Capital Assets – A LETTER IN RESPONSE
This letter is intended to give you a better understanding of the importance of holding period to your investment strategy, as well as how to measure holding period for federal income tax purposes.
Holding period makes the greatest difference in determining whether an asset is entitled to short-term or long-term capital gain treatment. At today’s rates, that can be the difference between being taxed at the highest ordinary income tax rate of 35% and the long-term capital gain rate of 15%. Although an investment strategy should not postpone good economic decisions in order to benefit from the 15% long-term capital gain rate, it should consider postponing action when a “sell” decision is made just short of the one year and a day holding period necessary for long-term capital gain. By the same token, however, a decision to sell an asset at a loss may involve timing the sale prior to the one year and one day holding period, to take advantage of short-term capital loss treatment.
The basic rules for holding period include the following:
Long- and short-term capital gain. In general, the capital gains rates of 15% (or 5%, reserved for those in the 10% and 15% regular income tax bracket) applies for the sale of capital assets. In general, this includes all investment assets, and for individuals it includes assets held for business income purposes. Assets must be held for one year and one day to be entitled to long-term capital gain treatment. That requires keeping track of exactly when a property is purchased (when the asset is sold, not the date the sales contract is executed; for stocks, it is the trade date that counts, not the settlement date).
Determining holding period. In determining how long an asset was held, the taxpayer begins counting on the date after the day the property was acquired. The same date of each following month is the beginning of a new month regardless of the number of days in the preceding month. For example, if property was acquired on February 1, 2003, the taxpayer’s holding period is considered to have begun on February 2, 2003. The date the asset is disposed of is part of the holding period.
5-year holding period eliminated. The 2003 tax legislation has eliminated a special rate that had applied to assets held for more than five years. That rate was 8 percent for those in the 10 or 15 percent tax brackets and 18 percent for those in the higher brackets. Those in the former category had the 8 percent rate available for tax years 2001 and 2002. For the latter group, the rate would only have applied for tax years after 2005. In order to qualify for the 18 percent rate on assets held before 2001, however, a taxpayer had to have made a “deemed sale election,” on which appreciation up to 2001 was taxed immediately. Since that “deemed sale election” is now useless, any taxpayer who made a “deemed sale election” should file an amended return immediately.
Wash sales. Where there has been a wash sale of securities, the holding period of the securities acquired includes the period for which the taxpayer held those securities on which the loss was not deductible.
Options. In determining whether a capital gain on stock is long-term or short-term, the holding period begins on the date after the option is exercised, not the date the option is granted.
“Carryover” holding period. In determining the holding period for long-term capital gain and loss purposes, the holding period is “tacked on” to another person’s holding period in the case of gifts or property received in a divorce. Additional rules when business assets are distributed to owners or partners may also apply.
If you have any further questions in regard to how tax holding period rules may apply to your particular situation, please do not hesitate to call.