How Soon Can I Sell My Stock After Exercising My Options?

Also, the rules on donating appreciated securities, how Roth IRAs affect Social Security benefits, claiming the child tax credit when you file separately and more.
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Happy New Year from the Tax Forum!

We're ringing in 1999 with some great questions. Read on to find out whether the

Roth IRA

will affect your

Social Security

benefits; if you can take the $400 child tax credit when you are married and filing separately and what your charitable deduction would be if you donate appreciated stock. (I promise that I won't mention that you have only 103 days until April 15.)

But since we are getting closer to the big day, keep sending your questions along to

taxforum@thestreet.com. Please include your full name.

Have ISO Rules Changed?

My wife works at Intel (INTC) - Get Report and receives stock options. In order to receive long-term capital gains treatment, it is my understanding you have to hold the stock for one year after exercising the option. However, another Intel employee says her accountant told her this rule had been changed. She thinks you can exercise the option, sell the stock immediately and receive long-term capital gains treatment. Can you verify this rule change and comment on it? David Craze

David,

I am assuming that your wife received incentive stock options, or ISOs, rather than nonqualified stock options, which are subject to different guidelines. If that's the case, the rules have not changed, according to

Clarence Kehoe

, partner and director of employee benefits at

Anchin, Block & Anchin

(full disclosure -- our accountants).

Your wife must hold the stock for two years after the option is granted and at least one year after the ISO was exercised to qualify for the favorable long-term capital gains rate. See

Section 422(a)(1) of the tax code for more on that.

For an overall refresher on ISOs, check out this previous

Tax Forum.

What's My Charitable Deduction?

If I donate appreciated securities I have held less than one year to charity, can I deduct the full value or just my cost basis? I have heard different answers to this and do not know if there has been a recent change in the law. Bill C. Burton

Bill,

The cost of the shares will be your charitable deduction, unless your donation is to a private foundation.

The rule says that, generally, when you contribute property to a charity, you get a charitable deduction at the fair market value of the property you donated, says Kehoe. But there's a big exception here. If you were to sell the property you're donating today and it generates ordinary income, then your charitable deduction will be limited to your cost basis in the shares.

In your case, if you were to sell your shares today, you would generate a short-term capital gain, taxed at your ordinary income tax rate. That means you've created ordinary income. Your deduction is therefore limited to your original cost of the shares.

Check out

Publication 526

- Charitable Contributions

for more details.

If you are donating to a private foundation, your charitable deduction will be the fair market value of the shares, regardless of how long you have held them. See a previous

Tax Forum for more discussion of private foundations.

Does the Roth Reduce Social Security Benefits?

I just read for the third time that converting to a Roth IRA can reduce taxes on Social Security benefits. The idea is that distributions from a Roth IRA are not taxable (after waiting five years), so they won't make Social Security benefits taxable. I had previously asked my tax accountant about this and she said that it wasn't so -- that only earned income affected the amount of Social Security that is taxable. Who is right? Ralph Sierra

Ralph,

There are two different issues here.

First, a distribution from a traditional IRA or a Roth IRA is not considered earned income for Social Security purposes, says Kehoe. So, you'll be happy to know that a distribution from either will not affect your Social Security income eligibility limits.

Second, if your income jumps up above $32,000 on a joint tax return, your Social Security benefits may be taxed, as we noted in a previous

Tax Forum.

A traditional IRA distribution must be included in income, so it can bump you over the income limit. But -- there's always a "but" -- a distribution from the Roth IRA will

not

affect the taxability of your benefits. Chalk another one up for the Roth.

No Child Tax Credit When Filing Separately

My wife and I file separately so we can save on state income taxes. We have two 12-year-olds. Can we file separately and claim the $400-per-child tax credit or do we have to file jointly? Jeff Yoder

Jeff,

First, some assumptions: The kids live with you and your wife in your home and you provide full financial support for them. Also, you and your wife lived together during the last six months of 1998.

That said, if you and your wife file separately, neither of you will be eligible for the $400 child tax credit.

You would get the credit if you filed a joint return, according to

Section 21(e)(2).

Here's an exception: If you happened to live apart for the last six months of the year, the IRS would consider you to be "unmarried." Then, whichever spouse is supporting the children could claim the deduction.

Check out the instructions to

Form 2441

- Child and Dependent Care Expenses

and

Publication 503

- Child and Dependent Care Expenses

for more details on this issue.

I Rented Out My House

I rented my home to a friend while I was on leave from my job and out of town. My friend paid me fair market rents for four months between Aug. 10 and Dec. 9. I did not move back to my home until the end of the following January. If I take the depreciation of my house in the year I rented it out, what tax consequences will I incur? Will I have to recapture the depreciation in the following year? What tax obligation will I have when I sell my house, say, in 2000? Jim Chan

Jim,

If you rent out your home for more than 14 days, which you have, you must report the rental income on

Schedule E

- Rental Income

. You can then report associated expenses like mortgage interest, real estate taxes, casualty losses and depreciation.

But the way depreciation works is that you "use it or lose it," says Bruce Wertheim, a personal financial services senior manager at

KPMG Peat Marwick

. So technically you must take the deduction.

Remember that taking depreciation will reduce the basis in your home. But those four months of depreciation will only put a small nick in your overall basis in the house, notes Wertheim. So you don't have to sweat it.

As far as recapture goes, as long as you use the straight-line method of depreciation (the cost of the asset less its salvage value, divided by the number of years in the asset's life), you won't have to worry about recapturing the depreciation when you sell the property, says Wertheim. See

Section 167 of the tax code for more on the depreciation rules and

Section 168 for a discussion of the different depreciation methods.

There are a bunch of other issues to consider here. First, there are these terrible sticky rules, called the passive activity rules, that you really need to make sure don't affect you. And second, when you decide to sell, you want to make sure the home was your principal residence and that you owned it for two of the last five years so that you will not pay tax on the first $500,000 of gain generated (or $250,000 for a single person). Check

this story for more on the cap gains exclusion rules and

this one for details on how to sell a rental property.)

Either way, be sure to check with a professional.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.