One day is very important!
The preferential 0 percent/15 percent/20 percent rates do not apply to all types of long-term capital gains and dividends. Specifically:
- The reduced rates have no impact on investments held inside a tax-deferred retirement account (traditional IRA, Keogh, SEP, solo 401(k), and the like). So, the client will pay taxes at her regular rate (which can be as high as 39.6 percent) when gains accumulated in these accounts are withdrawn as cash distributions. (Gains accumulated in a Roth IRA are still federal-income-tax-free as long as the requirements for tax-free withdrawals are met.)
- Clients will still pay taxes at their higher regular rates on net short-term capital gains from investments held for one year or less. Therefore, if the client holds appreciated stock in a taxable account for exactly one year, he could lose up to 39.6 percent of his profit to the IRS. If he instead holds on for just one more day, his tax rate drops to no more than 20 percent. The moral: selling just one day too soon could mean losing a much bigger chunk of one’s profit to the tax collector.
- Key Point: For tax purposes, the client’s holding period begins the day after he acquires securities and includes the day he sells. For example, say your client buys shares on November 1 of this year. His holding period begins on November 2. Therefore, November 2 of next year is the earliest possible date he can sell and still be eligible for the reduced rates on long-term capital gains. (See Rev. Ruls. 66-7 and 66-97.)