SECTION 3. APPLICATION OF § 1(h)

TO RIC AND REIT CAPITAL GAIN DIVIDENDS

For taxable years ending on or after May 6, 2003, the rules described in Notice 97–64 continue to apply to capital gain dividends of RICs and REITs, with appropriate modifications to take into account the changes that have been made to § 1(h) since that notice was published. Thus, if a RIC or REIT designates a dividend as a capital gain dividend, the RIC or REIT may make an additional designation of the dividend as a 15%-rate gain distribution, subject to the limitations described in section 5 of Notice 97–64, including the limitation that the additional designation of a class of capital gain dividend not exceed the maximum distributable amount in that class.

In general, a RIC or REIT determines the maximum distributable amounts that may be designated in each class of capital gains dividends by performing the computation required by § 1(h) as if the RIC or REIT were an individual whose ordinary income is subject to a marginal tax rate of at least 28 percent. The maximum distributable gain in each class of capital gain dividends is equal to the amount that, in the computation under § 1(h), is multiplied by the corresponding rate gain percentage. The computation under § 1(h), however, is modified in the following ways:

dividend income. That is, net capital gain is not increased by qualified dividend income, and qualified dividend

June 1, 2004 982 2004-22 I.R.B.

In taxable years beginning on or after May 6, 2003, some taxpayers may receive a RIC or REIT distribution amount that is designated as a 20%-rate gain distribution and that includes a portion constituting 5-year gain. As a result of the repeal of the separate rules for 5-year gains, the 5-year gain portion of that 20%-rate gain distribution is not subject to the prior-law 8-percent rate for 5-year gain. These taxpayers, however, will not be disadvantaged by the rate changes. The 5-year gain portion will be treated the same as any other 20%-rate gain distribution that is received in a taxable year beginning on or after May 6, 2003, and therefore will be taxed at a rate no higher than 15 percent (5 percent for certain taxpayers). Any taxpayer that would have been eligible in a taxable year to pay tax at the 8-percent rate for some or all 5-year gain had the prior rates remained in effect will be eligible under the new rules to pay tax on that amount of 5-year gain at the 5-percent rate.