Residential Capital Gains Strategy For 2009 - Impact of New Law

If you have turned your primary residence into a rental, a second home or a vacation home and are planning to sell it, you should be aware of a new law that changes how capital gains are calculated beginning January 1, 2009. You may want to change your strategy while there is still time.

The Current Law.

Currently, the law excludes up to $250,000 ($500,000 if married filing a joint return) of gain realized on the sale or exchange of a primary residence. The sale of a home qualifies for this exclusion if the home was the primary residence of the tax payer for at least two of the five years ending on the date of sale or exchange. The exclusion applies even if the home was originally purchased as a second home.

The New Law.

Rethink your strategy because on January 1, 2009, the rules will change. President Bush signed The Housing and Economic Recovery Act of 2008 (H.R. 3221) on July 30, 2008. The tax law name of this same law is The Housing Assistance Tax Act of 2008. This law will generate tax revenue by reducing the home sale exclusion, but it also provides a friendly transition for taxpayers.

The law does not allow a taxpayer to claim exclusion for any period of time after December 31, 2008, in which the home is not the main home of the taxpayer. The available exclusion is apportioned in the ratio that the period the home was the primary residence (qualifying use) bears to the period of ownership after December 31, 2008. Any nonqualifying use that occurred prior to January 1, 2009 is ignored. The maximum excludable amount remains at $250,000 or $500,000, depending on your marital status.

An Example.

If a homeowner purchased a house in 2009 for their main home, turned it into a rental property in 2012 and sold it 2014, the property would not have been used as a primary residence for 2 years of the five years it was owned (or 40% unqualified use). Under these circumstances, 40% of the gain realized from the sale would be subject to capital gains tax. The remaining 60% of the gain would be excluded up to the maximum amount allowed.

Temporary Absences.

Being absent from the property for temporary periods of time that are not greater than two years will not threaten the status of a home as a primary residence. A home can still be the primary residence of the taxpayer when he/she is absent because of a change in employment, health conditions or other unforeseeable circumstances.

Time Remains To Do Tax Planning.

Because the new law uses a test period of January 1, 2009 to the date of sale, the highest tax advantage is gained by using the home entirely as a primary residence during this period of time. Taxpayers who are planning to sell a vacation home, a second home or a rental home, may want to discuss with their tax advisors whether to move into the home on or before January 1, 2009, to accumulate as much qualifying use as possible before the home is sold. There is still time to do some planning to gain a tax benefit from this change.
This article is intended to be a general discussion of the topic area and is not to be considered as legal or tax advice for your specific circumstance. Always seek and rely upon the advice of a reputable accountant, tax advisor or tax attorney before taking any action about your personal situation.

This article is intended to be a general discussion of the topic area and is not to be considered as legal or tax advice for your specific circumstance. Always seek and rely upon the advice of a reputable accountant, tax advisor or tax attorney before taking any action about your personal situation.

Alternative Minimum Tax Impact From Investing Activities

Income that is earned from investments is a significant factor in the amount of Alternative Minimum Tax an individual pays. Certain types of investment income (dividends, capital gains, certain interest, e.g.) as well as the amount of this income in relation to the taxpayer's other income, all factor into the AMT formula. A taxpayer usually has much more control over investment income than he does his salary, for example, making this source of income much more important from an Alternative Minimum Tax planning point of view. In general, an investment portfolio can be changed any time a taxpayer finds it advantageous to do so.

Discussed below are a few key items associated with investing activities, and the AMT planning opportunities that may exist.

Dividends and capital gains

Most dividends on common stocks are "qualifying," and, thus, are eligible for a lower tax rate than "ordinary income," which consists of things such as salaries and wages, interest income, rental income, and the like. Similarly, a capital gain that qualifies as a "long-term" capital gain also is eligible for this lower tax rate. Even though the tax rate on dividends and capital gains is the same for both the Regular Tax and the AMT, the effect on a taxpayer's exemption amount can mean that these items of investment income are the reason a taxpayer is paying the AMT.

Planning strategy - determine the real tax rate being paid on dividends and capital gains. For maximum returns, investors should always consider after-tax yield when evaluating investment alternatives.

Tax-exempt bond interest

In general, municipal bond interest is exempt from Federal tax. However, certain muni bonds are designated "private activity" bonds, depending on how the proceeds of the bond issuance are used. Interest from private activity bonds continues to be exempt for the Regular Tax, but it is fully taxable for the AMT, with the result that the after-tax yield is significantly less than what the taxpayer originally thought he was earning. Note that, in order to boost yields, certain muni bond funds may allocate a portion of their portfolios to private activity bonds.

Planning strategy - Again, a taxpayer always should be considering after-tax yield in evaluating investments. An AMT payer generally should not be holding private activity bonds. If the investment is in mutual fund form, there are plenty of muni bond funds available that do not invest in private activity bonds.

Partnerships and other "pass-through" investments

In many cases partnerships themselves will have AMT items, but since a partnership "passes through" these items, it is the individual partner who ends up paying the AMT. For example, a real estate partnership may use a depreciation method that is allowable for the Regular Tax but is not allowable for the AMT. This difference in depreciation methods is an AMT item that will be reported to the partner on the Form K-1 he receives from the partnership, which, in turn, must be reported on the partner's own AMT schedule, the Form 6251.

Note that this same pass-through treatment results in the case of S corporations, LLCs, and certain estates and trusts.

Planning strategy - Before investing in a partnership, an individual should inquire about AMT items that the partnership may generate. Once invested, it generally is too late to do anything about them.

Conclusion

While the old maxim that taxes should not determine an investment strategy is true, nevertheless an investor who is stuck in the AMT may be earning a significantly lower after-tax yield on his investments than he realizes. Remember that it is only after-tax income that an investor actually gets to keep; ignoring taxes, especially the AMT, is unwise.

Impact of the Capital Gains Tax Increase on the Sale of a Business

Business owners and management teams that are contemplating a sale of their company are now evaluating the impact that the 'timing of sale' has on the net proceeds received, as a result of the upcoming 33% capital gains tax increase. Many business owners have seen a decline in revenue and profit over the last several years and are expecting an improvement in the future. Since most business valuations are derived, largely in part, by the earnings the company generates, the general consensus is that a higher value will be obtained by delaying the sale. Achieving the highest business valuation is often the sole concern with little consideration to the net after tax dollars. Many business owners are now re-evaluating this thought process given the significant capital gains tax increase that will take place on January 1, 2011.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 was signed into law on May 28, 2003. Among other things, this 2003 tax law created lower dividend and capital gains rates for all investors. Under this Act, the maximum net capital gains tax for assets held for more than one year was lowered from 20% to 15% (and from 10% to 5% for taxpayers in the 10% or 15% tax bracket). The Tax Increase Prevention and Reconciliation Act of 2005, which extended the 15% capital gains tax rate, "sunsets" on January 1, 2011. The term sunset is a time phase-in provision which means that without further Congressional action, the previous law, including the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), will go back into effect. Therefore, the top 15% capital gains rate will revert to its former pre-May 6, 2003 level of 20%, effectively a 33% increase.

This tax increase should be one of many factors that are considered when evaluating the optimal time table for a business sale. For those owners or management teams that do not plan to sell for 5-10 years this event should not become an inducement to rush out and sell the company. For those owners that are considering a sale over the next few years, the impact that this tax increase has on the after tax dollars received in a sale could be very significant and therefore, a thorough evaluation should be performed by the owner to assess the actual effect between selling a business now or years in the future. By analyzing the net after tax proceeds from a business sale in years 2010 thru 2013, the business owner or management team will recognize that even with a 10-15% growth per year, and maintaining consistent earnings with a constant exit multiple, the incremental value attributed by the growth in income and revenue, in most cases, would be completely negated by the increase in capital gains taxes. Therefore, while the value of the business is anticipated to be higher in years 2011 and beyond, the net after tax proceeds, could be considerably less.

There are many considerations involved in the sale of a privately held business and this article is written with the intention of helping business owners understand the potential impact that the 2011 capital gains increase will have on the sale of their privately held business. Understanding the effect of the impending capital gains tax increase enables business owners to make informed decisions as it relates to maximizing the net after tax dollars through the intelligent structuring and timing of the business sale transaction. The tax implications will vary for every business based upon the type of assets being sold and the structure of the transaction and it is strongly recommended that a business tax advisor be involved in the process.

Predicted Capital Gain Tax Increase and Its Impact

For the past couple of years the financial sector has been going through a rough time them and their business owners. The long list of people that are affected by in terms of limited credit wonder if there is a good long term plan in mind ready to be put in place.

When it comes down to reasons for getting a merger and acquisition they are many. One of the main reasons for this is that it improves economic indicators, the heavy balance sheets of strategic buyers and also funds raised from private equity group are very important in getting the full confidence of both the public and private sectors. And also for some potential sellers it is wise to think about the risk of valuation which will occur in the coming year. The act which was signed in 2001 was the economic growth and tax relief reconciliation act; this was crated by president bush and was created to reduce capital gains.

The rules of this act were that the new rate for capital gains and qualified dividends would be 15% as the two lowest categories. The original date for this tax plan to expire was 2008, but it was then extended by the bush administration for another two years which will be the end of 2010. And when this low tax rate ends it will be back at the rate of 2003 which was 20%. The increase in the rate of capital gains are at 33.33% higher, this could lead to more people making sale before a certain prescribed time which would be better for them.

India's Direct Tax Code and How it Will Impact Wealth Creation From Next Year

India is soon going to have a new set of rules for direct taxes, which will replace the 50-year-old Income Tax Act.

The so-called Direct Tax Code, which is scheduled to come into force from financial year 2011-12, had prescribed removal of almost all tax rebates in individual investments but also proposed raising the income limits for various tax slabs drastically.

However, the proposals drew sharp reactions and after reviewing some 1,600 public suggestions/comments, the government on Tuesday unveiled a more polished version of the code, which toned down some of the proposals.

As per the revised paper, provident funds and pure life insurance products will continue to enjoy the so-called exempt-exempt-exempt - suggesting tax exemptions in the three stages of investment, accrual of gains and withdrawal of investment - a status they now enjoy.

"It is proposed to provide the EEE (exempt-exempt-exempt) method of taxation for government provident fund, public provident fund and recognised provident funds..." the discussion paper said.

The paper clarified that the EET (exempt-exempt-tax) regime should be restricted to new savings instruments after DTC comes into effect, and the same should not apply to existing saving instruments.

Ulips or unit-linked insurance plans - which have been at the centre of a public debate of late - have been brought under the EET regime after the DTC comes into force.

Similarly, stocks investors will no longer be able to enjoy tax-free gain from long-term investment in equities as the DTS proposes to treat both short-term capital gains as well as long-term capital gains for tax calculation purposes.

Moneyguruindia tax experts analysed the proposals threadbare and came up with a detailed analysis of the tax incidence on various investment instruments as proposed under the new rules.

PAY AND PERKS:- The proposal to bring in perquisites like government accommodation to be part of salary has also been dropped. All perks will continue to be taxed as per existing norms. First draft didn't not find favour with the salaried class

INCOME TAX SLABS:- Revised DTC silent on personal income tax rates and slabs. First draft suggested 10% tax on income from Rs 1.60-10 lakhs and 20% on income between Rs 10-25 lakhs and 30% beyond that. Revenue secretary says these slabs are only illustrative and they will be fixed at the time of notifying the tax code

HOME LOANS:- Government decides to continue with the major tax incentive on housing loans. Revised draft says home buyers will continue to get tax benefit on payment of interest on home loans up to Rs 1.5 lakh annually. Actual rental income will be taxed.

INSURANCE AND ULIPS:- No tax proposed on life insurance products under exempt-exempt-exempt norm. New Ulips issued after DTC becomes operational will be taxed on maturity or withdrawal. Existing Ulips will be exempt from tax either on maturity or withdrawal midway.

EQUITY MUTUAL FUNDS: - The draft DTC proposes long-term capital gains tax on units of equity funds. At present, equity funds that lock in investments for more than three years enjoy tax exemption as there is no long-term capital gains tax. The draft DTC proposes to compute long-term gains on equity and equity funds after allowing a deduction at a specified percentage of capital gains without any indexation.

STOCKS INVESTMENT: - The difference between long-term and short-term capital gains has been eliminated. Capital gains will be treated as income from ordinary sources and taxed at applicable rates. Specific rate of deduction for capital gains is to be finalised. But not tax on capital gains from savings schemes.

PROVIDENT FUND: - The proposal to tax government provident fund (GPF), public provident fund (PPF) and pension funds withdrawals has been dropped. It is proposed to provide the EEE (exempt- exempt-exempt) benefit to GPF, PPF and recognised provident funds. First draft had proposed to tax all savings schemes including PF's at the time of withdrawal.

PENSION PRODUCTS: - Revised draft puts pensions administered by PFRDA, including pension of government employees recruited since January 2004, under EEE treatment, means no tax any stage. "In the absence of adequate social security benefits, taxation of withdrawals from retirement benefits would be harsh," says the revised DTC.

By UDAY SHANKAR

The Changes in Capital Gains Tax and How it Will Impact on UK Landlords

A tax giveaway for landlords?

Landlords are set to be one of the main beneficiaries from the proposed tax changes signaled by the Chancellors Pre-budget Statement last week. This Statement which outlines what changes are to be made for the tax year 08-09 or effectively the tax regime that is to come into force on the 6th April 08. How much is it a give away and are landlords better to sell now under the current capital gains tax regime or should they wait? In this article I set out to investigate what it means to landlords

The current taxation regime

The current system of Capital Gains Tax (CGT) was actually put in place by Gordon Brown in April 1998 when he introduced a system of taper relief to replace the previous system of indexation. The whole idea behind taper relief was that it encouraged businesses and property investors to hold their assets for the long term and discourage short-term investment speculation. The result was a taxation system where the amount of tax paid reduced the longer the landlord held their buy-to-let investment property for up to a maximum relief being given after 10 years of holding their residential property investment.

When does Capital Gains Tax (CGT) apply?

Capital gains tax is a tax that landlord's only pay on disposal of their buy-to-let investment property. It is treated as a top slice of taxable income and therefore the rate that a landlord will pay will depend on what income the landlord has earned in the year of disposal. In calculating a landlord's potential Capital Gains Tax (CGT) tax liability a landlord will have to apply the following concepts to their Capital Gains Tax (CGT) calculation.

1. A landlord should establish the base cost of their buy-to-let investment (effectively cost of acquisition)

2. A landlord should establish the size of the gain by taking base cost from disposal value

3. A landlord should establish if buy-to-let investment held as a non-business or as a business asset (most will be non-business, whilst holiday rentals are classed as a business asset)

4. If the buy-to-let investment property is held as an individual not by a company the landlord can use their annual exemption 2006/2007 £8800 to reduce the amount of the chargeable gain

5. For properties bought before April 6 1998 the gain is subject to indexation

6. Properties bought on or after April 6 1998 the gain is subject to taper relief

Effective rate of Capital Gains Tax (CGT)

For most landlords the effective rate of Capital Gains Tax (CGT) that a landlord will pay depends on their rate of income tax. For a landlord who is a basic rate taxpayer the effective Capital Gains Tax (CGT) rate could reduce to 12% as the percentage of the gain chargeable reduces to 60% after 10 years and this is then charged at 20%. For landlords who are top rate taxpayers the effective rate is double as they pay 40% tax.

The new regime

The new Chancellor Alistair Darling is planning to sweep away the old systems of indexation and taper relief carefully put in place by the previous Chancellor and replace the systems of indexation and taper relief with a single flat rate of 18%.

The verdict for UK landlords

On balance the news for landlords is good. The new flat rate Capital Gains Tax (CGT) will apply to a landlord immediately and means that for a high rate tax payer they will be paying 6% less than they would have done after 10 years under the previous system of taper relief. For basic rate taxpayers things are less clear cut. Under the previous system a basic rate taxpayer would have had to have held their buy-to-let investment property for 4 years before benefiting from a rate as low as 18%. However, this would have eventually reduced to 12% after 10 years or 6% below the rate that will come in on 6th April 2008.
A couple of beneficial points for landlords are that the new system is much simpler to understand and should make property investment disposal decisions and calculations much easier for landlords.

It also makes it far more attractive for landlords to trade their buy-to-let investments buying and potentially renovating a property, holding for a couple of years before then selling their buy-to-let investments on.

However, this may not be so much of a tax gift to landlords as it first appears. For a start, the anticipated slow down in the UK housing market may mean that the opportunities for buying a property and doing it up to rent and then dispose may not be as prevalent as they have been over the last 10 years of the housing boom. Also landlords should be aware that if they are doing this regularly the tax authorities may consider that the landlord is actually engaging in a trade and tax any profit as income anyway.

The reality is for most landlords buying a residential investment property is seen as a long-term investment. ARLA the Association of Residential Letting Agents latest quarterly survey (Sept 07) of landlords showed that 66% of landlords questioned intended to keep their residential investment properties for more than 10 years. These landlords would therefore have benefited from the maximum taper relief available anyway.

The proposed tax changes appear to be a classic case of smoke and mirrors where tax for some landlords i.e. high rate tax payers looks to have come down whilst those for lower rate tax risers potentially goes up.

Should landlords sell?

This potential change in the tax law has thrown up an interesting conundrum for some landlords over what to do over their buy-to-let investments.

Previously the tax system strongly encouraged them to hold their properties for the long-term to maximise their taper relief. Now, for a lower rate taxpayer who has owned their property for 10 years or more a quick disposal before the new regime would save them potentially a considerable sum.

Equally for high rate taxpayers who were thinking of a sale, holding out until the new tax regime is in place could also save them a sizeable amount of money.

Therefore, all this has to be weighed by a landlord against their wider and long-term financial plans and aspirations. If the housing market does weaken considerably by next year selling at a time of low housing demand may not be the best time to exit the market even where a tax saving.

2011 Capital Gains Tax Increase and the Impact on Business Owners

The last couple of years have been difficult for business owners and financing markets, to say the least. Limited credit, economic uncertainty among businesses and consumers, and poor financial performance across industry sectors contributed to curtailed growth prospects, and have some wondering what their long-term strategy might entail. As we head into 2010, however, there are many reasons for optimism that merger and acquisition activity will increase, including improving economic indicators, cash heavy balance sheets of strategic buyers, better than expected fund raising by private equity groups and Key Take Aways increased confidence in the private and public sectors. For potential sellers, 2010 is also an important time to consider valuation risks now versus future years due to the scheduled increase in the capital gains in 2011.

Originally signed into law in 2001, the capital gains tax rate was reduced as part of President Bush's Economic Growth and Tax Relief Reconciliation Act. Under the reduced rate, long-term capital gains and qualified dividends were taxed at 15% for the lowest two income tax brackets. The lowered rate was set to expire in 2008; however, reduced rate was extended in 2006 under Bush's Tax Reconciliation Act and is scheduled to expire at the end of 2010, at which time the rate will revert to the 2003 rates, which were 20%.

Given the capital gains tax rate increase represents a 33.33% higher effective tax rate, there is significant motivation for owners and shareholders already considering a potential sale in the near-term to consider action in 2010. Beyond avoiding a higher tax rate on long-term capital gains, sellers also need to carefully plan the timing of a potential exit in 2010 in order to secure the most attractive buyer and preserve leverage in the negotiations of the purchase agreement.

While owners and shareholders may be hesitant to pursue an acquisition without greater economic certainty, there are multiple indicators suggesting that 2010 is likely the right time to at least consider a potential a sale, given favorable terms. The capital gains tax increase serves as motivating factor; it is by no means the only one.

The following are key points for understanding the impact of the capital gains tax rate increase on M&A activity in 2010:

Consider the overall economic picture.

There are signs at the corporate level that are encouraging to mid-size firms considering being acquired. Over the last three months through January 2010, deal flow is up 16.8% over the same period a year before. Of course, last year was the one of the worst years in our economic history. However, major deals are being completed, which can cause a "bandwagon effect." In addition to corporate confidence, many private equity groups with a strong track record continue to raise money. In 2009, the average fund size raised by private equity groups was $1.5 billion, the second highest on record. This indicates more private equity groups than expected will have cash in 2010 and will need to put it to work. With a return in confidence to the markets and increasing signs of an economic stabilization, 2010 is likely to see a number of buyers enter the market with cash on hand seeking good deals.

Understand your long-term growth realities.

While the economy is expected to undergo further recovery in 2010, many mid-size firms are simply not going to be able to grow at the same rates experienced in the 2003-2008 period. Given modest growth expectations, overall business growth in the next three to five years will not be significantly higher than its current state in 2010.

It is projected that the economy will grow at an average rate of less than 3.5% for the next 3-5 year, which will mimic the growth of most industries. (There are, of course, exceptions to every rule.) Given this outlook, a company should consider a realistic growth projection as part of their calculations for keeping their business or selling it now or five years from now. This is especially so considering what will most likely be a higher capital gains tax rate in 2011 and beyond.

Think critically about timing.

Early in 2010, the market will be more favorable to sellers, who will have a range of potential buyers to choose from. Moreover, the capital gains tax rate increase puts buyers not paying all cash at a disadvantage, since the increased tax rate will apply to deferred payments at the time the payment is made. Deferred payments are likely to continue into 2011 and beyond for non-cash buyers. Therefore, sellers are more likely to find buyers with cash in hand earlier in the year.

In addition to increased choice of buyers, owners are in a better negotiating position earlier in 2010. As potential buyers know that sellers have a range of options and varying deal structures to minimize tax obligations, they are more likely to agree to terms favorable to the seller. As 2010 progresses, the buyer will be able to use the impending tax increase as leverage in deal negotiations, aware the seller has significant motivation to close before 2011. In fact, if negotiations are still ongoing in 4Q10, buyers are likely to try and discount the purchase price by 1% to 5% or seek tougher terms in the purchase agreement, knowing the seller will try and avoid paying the higher tax rate.

While not appropriate for all owners, those considering a sale in the near-term future are likely to experience favorable conditions 2010 as closing before year end avoids paying higher capital gains taxes. Additionally, early movement will prove advantageous for sellers by yielding a greater range of potential buyers and a strong position in deal negotiations. Overall, 2010 is likely to experience a significant revival in M&A activity, attracting a number of interested buyers to the market.