Holding Period Requirements
The Jobs and Growth Tax Relief Reconciliation Act of 2003 lowered the rates on long-term capital gains to 15% for taxpayers in the 25% bracket or higher and lowered the 10% rate to 5% for individuals in the 10% and 15% tax brackets, effective May 6, 2003, through December 31, 2007. This Act also eliminated the five-year holding period rates of 18% and 8%.
Effective January 1, 2008 through December 31, 2010 a 0% rate applies to net long-term capital gains and qualified dividends for taxpayers in the 15% and below ordinary income tax brackets, otherwise the rate is 15% for taxpayers in the 25% or higher ordinary income tax brackets.
The following table may help to keep these changes straight. The table is based on the date the timber is sold or otherwise disposed of, how long the timber was held prior to disposal, and the tax rate on ordinary income.
| Date of Disposal | If holding period is more than: | And, if tax rate on ordinary income is: | Then capital gains rate is: |
| After 5/6/2003 and before 1/1/08 | 12 months | 25% or higher | 15% |
| 12 months | 10% or 15% | 5% | |
| Before 5/6/2003 and after 12/31/10 | 12 months | 15% | 10% |
| 12 months | 28% or higher | 20% | |
| Between 1/1/08 & 12/31/10 | 12 months | 25% or higher | 15% |
| 12 months | 10% or 15% | 0% example below |
Applicability of zero percent capital gains rate: The zero percent capital gains rate applies to what could be called the 0% capital gains gap. This gap is determined by finding the upper limit of the 25% ordinary income tax bracket for your filing status. In 2008 this limit for married filing jointly is $61,500. From this limit subtract your taxable income with net long-term capital gains and qualified dividends excluded. This difference is the amount of your net long-term capital gains and qualified dividends that are taxed at the 0% rate. The amount by which net long-term capital gains and qualifed dividends exceed this gap is taxed at 15% rate. This is demonstrated by the following example:
Example 1 :
The salaries of Mr. and Mrs. Jones total $85,000 in 2008. Their additional income from interest and investments total $15,000. They are married and file jointly, take the standard deduction of $10,900, and two personal exemptions of $3,500 each. This makes their taxable income $82,100 and their tax liability $13,213. But, we need to look at their marginal tax rate. Here’s the break down for their tax liability. The first $16,500 of taxable income is taxed at 10% - $1,650. The next $49,050 is taxed at 15% - $7,357.50. The remaining $17,000 of taxable income is taxed at 25% - $4,250. Adding the tax for the three brackets: $1,650 + $7,358 + $4,250 gives the $13,258 tax due. The average tax rate on their gross income of $100,000 is 13.2%, but their marginal tax rate is 25%. The 25% rate applied to the last $17,000 of taxable income. The next higher tax rate of 28% starts when taxable income reaches $131,450.
Example 2:
Assume that the Jones in Example 1 also have a net long-term capital gain of $24,000 from a timber sale. Since their marginal ordinary income tax rate is 25%, above the 15% bracket, the applicable capital gains rate is 15%, making the tax on the timber $3,600.
Example 3:
Assume that the Jones taxable income with the $24,000 of capital gain excluded is only $42,100. This puts them in the 15% ordinary income tax bracket. An additional $23,000 of income is needed to move them to the next highest bracket. Thus, the first $23,000 of capital gains is taxed at the 0% rate and the balance of $1,000 is taxed at the maximum capital gains rate of 15%. This makes the capital gains tax $150 on the $24,000.
Example 4:
Assume the same facts as in Example 3, but the Jones have $12,000 of qualified dividends in addition to the $24,000 capital gain. The total amount taxed at a maximum rate of 15% is now $36,000. The first $23,000 ($65,100-$42,100) is still taxed at the 0% rate and the balance of $13,000 is taxed at 15%, making the tax $1,950.Note that no distinction is made as to whether it's the qualified dividends or the timber gain to which the 0% capital gains rate applies.