The Tax Relief Act of 1997 created two new long-term capital gain rates, 8% and 18%, for assets that have been held for more than five years.

Beginning in 2001, the 8% rate applies to long-term capital gains otherwise eligible for the 10% capital gain rate, if the property was held more than five years. The 10% rate generally applies to gain that would have been taxed below 20% if it were not capital gain. The instructions to Schedule D for 2001 will help you figure the amounts taxed at 8%.

The 18% rate will apply to long-term capital gains otherwise eligible for the normal 20% capital gain rate, if the holding period is more than five years. However, the property must have been acquired after December 31, 2000, so the 18% rate will not apply until 2006.

If you acquire an asset before 2001, you may still qualify for the 18% rate by making a one-time Special Election to treat the asset as though you had sold and reacquired it in 2001. Although you must pay tax on any gain from this "deemed sale" in 2001, the asset will then have a new holding period and any future gain will be eligible for the 18% rate in 2006.

Specifically, any asset for which you make the Special Election will be treated as if you sold it for its closing market price on January 2, 2001 (for readily tradable stock) - or for its fair market value on January 1, 2001 (for other capital assets, or property used in a trade or business) - and as if you reacquired it on the same day for the same amount. The asset's new basis will therefore be its market price, or fair market value, on the date of the deemed sale.

Any gain on this deemed sale must be reported. For example, if you make the Special Election for your main home, you cannot exclude the gain from your income under section 121. A loss from a deemed sale is not allowed, even though your basis in the asset is reduced by the election. Since the election is not meant to create further short-term gains or losses, it does not apply if gain or loss is recognized on a disposition of the asset within one year after what would have been the date of the deemed sale. Once made, the election is irrevocable.

To make the Special Election, report the deemed sale on your tax return - filed by the due date (including extensions) - for the tax year that includes the date of the sale. If you are a calendar-year taxpayer (January to December), then this is your 2001 tax return. Attach a statement to the return, stating that you are making an election under "Tax Relief Act of 1997, Section 311," and specifying the assets for which you are making the election. If you have filed a timely return, you may still make the election, or make it for additional assets, on an amended return filed before October 16, 2002.

For more information, refer to Publication 553 (PDF), Highlights of 2000 Tax Changes (Some of the changes for 2001 are included). When it becomes available, the 2001 edition of Publication 550 (PDF), Investment Income and Expenses, will provide additional information. You may also refer to the "Frequently Asked Questions", and/or the "Tax Trails" on the IRS web site.

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