A Peek at Capital Gains for 2013

The Health Care and Education Reconciliation Act of 2010 (HCERA) added Internal Revenue Code §1411, which imposes a new 3.8% tax on net investment income, effective January 1, 2013.

The new law imposes a 3.8% tax on the lesser of the taxpayer’s net investment income or the excess of the taxpayer’s adjusted gross income over the specified thresholds (i.e. $250,000 for married filing jointly; $125,000 for married filing separately; and $200,000 for other taxpayers).

In addition to the new 3.8% surtax on capital gain, the Bush tax cuts are set to expire beginning January 1, 2013, which will increase the top capital gains tax rate from 15% to 20%. With the new 3.8% surtax starting in January of 2013, the effective top capital gains tax rate will be 23.8%.

Since the issuance of HCERA, many taxpayers have expressed concern about whether an IRC §1031 exchange could be used to defer this additional 3.8% tax on capital gain. Now, under newly published “proposed regulations” — 26 CFR Part 1[REG-130507-11] — for those who were worried that an IRC §1031 exchange could not be used to defer this additional 3.8% tax on capital gain, §1.1411-5(C)(i)(2)(ii) alleviates that concern by providing as follows: “to the extent gain from a like-kind exchange is not recognized for income tax purposes under section 1031, it is not recognized for purposes of determining net investment income under section 1411.”

Although these regulations are not yet final, section 12 of the proposed regulations provides that taxpayers may rely on these proposed regulations for purposes of compliance with §1411, until the effective date of the final regulations.

Taxpayers should review the proposed regulations with their tax advisor to ensure proper compliance and interpretation thereof.

The proposed regulations may be viewed at the following link: https://s3.amazonaws.com/public-inspection.federalregister.gov/2012-29238.pdf. A hearing on these proposed regulations is scheduled for April 2, 2013.

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