New Income Tax Rules for 2011 Mean Higher Capital Gains Taxation

If you are holding onto stocks that have appreciated (or depreciated) over the past several years and are looking to sell them in the near future, you may wish to do so before the end of 2010. The reason is because the U.S. Congress will soon be passing some new income tax laws, including laws that may result in higher long-term capital gains tax.

Capital gains taxes are income taxes that are paid on stock investments that appreciate and are then sold off. If the stocks are sold over after a year (or more) after being initially purchased, they are taxed a long-term capital gains tax. If the stocks are sold in less than a year after initial purchase, they are charged a short-term capital gains tax. Long-term capital gains tax is significantly lower (or even negligible) compared with short-term capital gains tax.

The Bush tax cuts of 2001 and 2003, which are set to expire at the end of 2010, resulted in the shifting of consumer income tax brackets from the much higher 15%, 28%, 31%, 36%, and 39.6% brackets to the lower 10%, 15%, 25%, 28%, 33%, and 35% brackets. Individuals in the lowest two tax brackets were not taxed at all for any long-term capital gains, and individuals at the 25% tax bracket or above were taxed at 15%. Short-term capital gains were taxed at individual income tax bracket levels.

In 2011, income tax rates will change, with individuals in the two lowest tax brackets being taxed at 10% for long-term capital gains, and everyone else being taxed at 20%. Short-term capital gains taxes will also increase for some individuals, as individual income tax bracket rates will be higher.

What can you do to offset these tax increases? If you sell your long-term gain stocks before 2011, you will be assessed the 2010 capital gains tax rate. This rate will hold even if you buy back all the stocks you had sold in 2010 in 2011. In theory, you could sell your appreciated long-term stocks on December 31, 2010, buy them all back on January 1, 2011, and still be taxed at 2010 tax rates.

There is nothing illegal about selling and buying appreciated stock in such rapid succession in order to save on capital gains taxes. However, the "wash sale rule" does make it illegal to sell and buy back depreciated stock in order to offset capital gains on other stock. Therefore, if you are planning on selling the same stock in one year and then buying the same stock back the next year, make sure it is stock that has made you some money.