7.5 Capital Gain Treatment for Pre-1974 Participation

The portion of a qualifying lump-sum distribution attributable to pre-1974 participation is eligible for a 20% capital gain rate if you were born before January 2, 1936, and the other tests (7.2) are met.

On Form 1099-R, the plan paying the lump-sum distribution shows the capital gain portion in Box 3. The ordinary income portion is Box 2a (taxable amount) minus Box 3. If you elect to treat the pre-1974 portion as capital gain subject to a flat rate of 20% on Form 4972, the tax on the balance of the distribution may be figured under the averaging method (7.4). The 20% rate for the capital gain portion is fixed by law, and applies regardless of the tax rate imposed on your other capital gains. Alternatively, you may elect to treat the capital gain portion as ordinary income eligible for averaging on Form 4972. You may not elect to report any portion of the pre-1974 portion of the lump-sum distribution as long-term capital gain on Schedule D.

Under the one-time election rule, if you elect to apply the averaging and/or 20% capital gain rule for a current distribution, you may not elect averaging or capital gain treatment for any later distribution.

Filing Tip

Pre-1974 Capital Gain Portion of Distribution

If you were born before January 2, 1936, and a portion of your lump-sum distribution is attributable to plan participation before 1974 (7.5), you may treat it as ordinary income eligible for averaging, or you may elect to treat it as capital gain taxable at a flat 20% rate; choose the method on Form 4972 that gives the lower overall tax.

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Capital gain treatment not allowed for individuals born after January 1, 1936.

If you were born after January 1, 1936, you may not treat any portion of a lump-sum distribution as capital gain. You may not apply the flat 20% rate to the pre-1974 portion of the lump-sum distribution on Form 4972, or include any part of it as capital gain on Schedule D.