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1 1 (July 15, 2003)

handle is hein.crs/crsmthaaghf0001 and id is 1 raw text is: Order Code 96-769 E Updated July 15, 2003 CRS Report for Congress Received through the CRS Web Capital Gains Taxes: An Overview Jane G. Gravelle Senior Specialist in Economic Policy Government and Finance Division Summary 1997 tax legislation reduced capital gains taxes on several types of assets, imposing a 20 maximum tax rate on long-term gains, a rate temporarily reduced to 15% for 2003- 2008. There is also an exclusion of $500,000 ($250,000 for single returns) for gains tax on home sales. The capital gains tax has been a tax cut target since the 1986 Tax Reform Act treated capital gains as ordinary income. An argument for lower capital gains taxes is reduction of the lock-in effect. Some also believe that lower capital gains taxes will cost little compared to the benefits they bring and that lower taxes induce additional economic growth, although the magnitude of these potential effects is in some dispute. Others criticize lower capital gains taxes as benefitting higher income individuals and express concerns about the budget effects, particularly in future years. Another criticism of lower rates is the possible role of a larger capital gains tax differential in encouraging tax sheltering activities and adding complexity to the tax law. What Are Capital Gains and How Are They Taxed? Capital gain arises when an asset is sold and is the difference between the basis (normally the acquisition price) and the sales price. Corporate stock accounts for 20% to 80% of taxable gains, depending on stock market performance. Real estate is the remaining major source of capital gains, although gain arises from other assets (e.g., timber sales and collectibles). The appreciation in value can be real or reflect inflation. Corporate stock appreciates both because the firm's assets increase with reinvested earnings and because general price levels are rising. Appreciation in the value of property may simply reflect inflation. For depreciable assets, some of the gain may reflect the possibility that the property was depreciated too quickly. If the return to capital gains were to be effectively taxed at the statutory tax rate in the manner of other income, real gains would have to be taxed in the year they accrue. Current practice departs from this approach. Gains are not taxed until realized, benefitting from the deferral of taxes. (Taxes on interest income are due as the interest is accrued). Gains on an asset held until death may be passed on to heirs with the tax forgiven; if the asset is then sold, the gain is sales price less market value at the time of death, a treatment referred to as a step-up in basis. Congressional Research Service **o The Library of Congress

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