Last week we talked about how to determine which tax year to report various year-end income and deduction items. I promised to continue today with a look at capital transactions.
The rules for reporting capital gains and losses are essentially the same as for other income and deduction items; that is, the gain or loss is reported in the tax year in which payment is received.
For example, if you sell a piece of rental property in 1981 and will be paid in installments over a period of years, you have to determine what percentage of the selling price represents capital gain (profit).
For 1981 add up any down payment plus the total amount of additional payments received by Dec. 31. Then multiply the total by the capital gain percentage. The result is the amount of gain to be reported on Schedule D this year.
(Form 6252, Computation of Installment Sales Income, should be used in the year of sale to report the details of the sale and to compute the applicable profit percentage.)
In 1981 and succeeding years simply multiply the total of all installment payments received by the profit percentage to arrive at the capital gain to be reported.
Caution: Each installment payment has two elements--the principal amount being paid, and the interest charge. The interest element is reported as ordinary income on Schedule B. Be sure to compute the capital gain only on the total of principal payments received.
A special rule applies to end-of-year sales of securities. Settlement date (five business days after the date of sale) determines the year for reporting a capital gain. But a loss goes into the year of the sale date.
So for 1981 Dec. 23--just two days from today--is the last day to sell stock if you want a capital gain for your 1981 tax return. But you have until Dec. 31 to create a capital loss for this year.
Question: I'm 65 years old. The company I work for is terminating its pension plan, and I'll be getting a substantial payoff--something like $22,000. Would it be wise for me to roll this money over into an IRA?
Answer: At your age this may not be the best way to go. If you do move the funds to a rollover IRA, you must begin withdrawals by the year in which you reach 70 1/2.
At that time you must either take all the funds or initiate periodic payments at a rate based on your remaining life expectancy.
So you really only have around five years to take advantage of the tax deferral feature of the IRA program.
What you probably ought to do is take the entire payout and pay the tax on it. There's a special provision in the rules for reducing substantially the tax you pay on this kind of a lump-sum distribution.
Called the "special 10-year averaging" method, this provision permits you to treat the distribution as if it had been received over a 10-year period.
So you calculate the tax on only one-tenth of the distribution (then multiply the result by 10), thus staying in a lower tax bracket.
And the tax is calculated from a zero base--that is, as if it were your only income, rather than being added to your salary and other income.
In addition, there is a sliding--scale exclusion of a part of the distribution (which disappears at the $70,000 figure). As a result of all these breaks, the federal income tax on a $22,000 distribution received in 1981 would amount to only $1,664.
(There are some special qualifying requirements, like having been covered by the plan for at least five tax years before the year of the distribution. See IRS Publication 575 for details.)
If you report the distribution now and pay the relatively low tax, the remaining balance is yours without further tax consequences.
But if you go the rollover IRA route, later distributions--which must begin within five years, as I said--will be taxed in full, and at your marginal (top) rate. The special 10-year averaging method is not authorized for a distribution from a rollover IRA (although normal income averaging would be).
Considering your age, I think it is more advantageous for you to report the distribution in the year of receipt, using the 10-year averaging to reduce the tax, rather than to go for the rollover IRA.