Tax at Capital Gains Rates is Good – You Can do BetterJanuary 10, 2020 | By Erik Lincoln
Paying tax at 20% on long term capital gains is pretty good. This equates to a savings of 17% over the highest federal income tax rate on ordinary income. But, you can do even better.
The Internal Revenue Code (“IRC”) provides several favorable Code sections for taxpayers that generate capital gain. They include the following:
- IRC §1202 “Partial exclusion for gain from certain small business stock”
- IRC §1031 “Exchange of property held for productive use or investment”
- IRC §1045 “Rollover of gain from qualified small business stock to another qualified small business stock”
- IRC §1400Z-2 “Special rules for capital gains invested in opportunity zones”
The purpose of this article is to make you aware of these other tax favorable Code sections and to provide a brief overview. Should you need further assistance on any of these, please do not hesitate to contact us.
IRC §1202 “Partial exclusion for gain from certain small business stock”
For businesses operating as C corporations, this Code section provides one of the most generous tax benefits available. Individuals that hold “qualified small business stock” (QSBS) for more than five years can exclude 100% of the gain realized on the sale or exchange of QSBS acquired after Sept. 27, 2010 (if acquired before Sept. 27, 2010, different exclusion amounts apply). There is a dollar amount limit on the amount of gain that gain be excluded, which is generally $10 million ($5 million for a married taxpayer filing separately), or 10 times the aggregate adjusted basis of the qualified stock disposed of by the taxpayer during the tax year. In addition to this limitation, the exclusion is subject to various other rules that would need to be considered prior to taking advantage of IRC §1202.
IRC §1031 “Exchange of property held for productive use or investment”
Many people are familiar with the like kind exchange rules. The like kind exchange rules were modified by the Tax Cut and Jobs Act of 2017 to apply only to certain real estate. Under IRC §1031, gain is not recognized on an exchange of real property where the following requirements are met:
- The taxpayer exchanges real property (relinquished property) held for productive use in a trade or business or for investment for other real property (replacement property) to be held for productive use in a trade or business or for investment.
- The relinquished property and the replacement property are “like kind”.
- The replacement property is identified and the exchange is completed within statutory time limits.
IRC §1045 “Rollover of gain from qualified small business stock to another qualified small business stock”
If the requirements noted below are met, a taxpayer can elect to roll over gain (i.e., receive nonrecognition of gain treatment) from the “sale” of QSBS. The requirement under §1045 include the following:
- the taxpayer seeking to roll over gain is an eligible taxpayer,
- the QSBS sold has been held by that taxpayer for more than six months,
- the gain isn’t treated as ordinary income, and
- the taxpayer makes a replacement stock purchase within 60 days.
IRC §1400Z-2 “Special rules for capital gains invested in opportunity zones”
This Code section was added as part of the Tax Cut and Jobs Act of 2017. It has gained a significant amount of interest. Where an eligible taxpayer with capital gain invests in an Qualified Opportunity Fund (“QOF”) within 180 days and makes the appropriate elections, the taxpayer is entitled to the following tax benefits:
- The capital gain is deferred until the earlier of 12/31/26 or an “inclusion event”;
- Tax on the capital gain can be reduced by 10% or 5%, depending on how long the QOF investment is held; and
- There is no tax on any gain that accrues while the QOF investment is held, if it is held for at least 10 years.
If any of the above provision apply to you, please contact us for further details.