Here's how you can encounter the alternative minimum tax (AMT) because of a long-term capital gain.
Congress didn't intend for the alternative minimum tax to apply merely because you have a long-term capital gain. When Congress reduced the capital gain rates in 1997 and again in 2003, it provided that the lower rates would apply under the AMT, too. But the way it works out, you may still pay AMT because of a large long-term capital gain.
The AMT exemption
A major reason for paying AMT in the year of a large capital gain is the AMT exemption. This is a special deduction that's designed to prevent the alternative minimum tax from applying at lower income levels. The problem is that the AMT exemption is phased out when your income goes above a certain level. For this purpose, capital gain is considered income, so it can reduce or eliminate your AMT exemption.
For example, if you're single and your income under the AMT rules is $112,500 or less, you're allowed an AMT exemption of $44,350. (This is the amount for 2007; Congress will have to take action to prevent the exemption amount from falling back to a lower level in later years.) Normally that's enough to prevent you from paying AMT unless you're able to claim unusually large tax benefits that reduce your regular tax. But suppose your income is around that level before you add a $200,000 capital gain (sale of a real estate investment, or stock, or perhaps sale of a business you built up). Your tax on the capital gain is 15% under both the regular tax and the AMT: $30,000. Under the AMT, though, the added income wiped out your AMT exemption.
How big is the effect? The answer depends on how close you are to paying AMT before this happens. Overall, a large capital gain can cause you to incur $10,000 or more of AMT.
Do the math
Here's how it works. For every $1,000 of added long-term capital gain, your regular income tax goes up by $150 (15%). When we move over to the AMT, the same $1,000 is taxed at 15%, but in addition eliminates $250 of your exemption amount, because the exemption is phased out at a rate of 25%. The exemption amount is used to reduce the amount of tax you pay on your ordinary income (the income that is taxed at either 26% or 28% under the AMT). So your tax under the AMT rules goes up by about $70, which is 28% of this added $250. You didn't really add another $250 of income, but your exemption amount went down by $250, and that exposed another $250 of your existing income to tax under the AMT.
Result? Under the AMT, adding $1,000 of long-term capital gain can increase your tax by as much as $220, consisting of the $150 tax on the gain itself and the $70 that hits you because the exemption amount is reduced. In effect, you're paying 22% on the gain under the AMT and 15% on the gain under the regular income tax, so a big capital gain can lead to a big AMT bill.
That doesn't necessarily mean you pay AMT every time you have a long-term capital gain. Most people have at least a little bit of a cushion between the amount of regular tax they pay and the level where they would have to start paying alternative minimum tax. (The size of your cushion depends on various items. See Top 10 Things that Cause AMT Liability.) Besides, the capital gain can cause some tax benefits to phase out under the regular tax, too. But there's a good chance you'll pay AMT if your income is in the range where the exemption amount is phased out and you have a large long-term capital gain.
More bad news
There's more bad news. People who get caught by the AMT because of a large long-term capital gain usually don't qualify for the AMT credit in later years. The AMT is being caused by items that aren't considered timing items. Possibly you have some timing items in addition to the large capital gain, and in that case at least part of your AMT would be available as a credit in later years. Typically this added tax is just a dead loss.
What to do
In many cases there isn't a lot you can do about this added tax. Sometimes, though, if you're aware of the issue, you may be able to take measures to reduce the impact.
Timing your capital gains
In some situations you can control the year in which you report capital gains. You may be able to delay a sale until after the end of the year, or spread the gain over a number of years by using an installment sale. There's no simple answer to whether these measures help or hurt, so someone has to sharpen a pencil and grind out some numbers.
For example, your gain may be at a level where spreading it over a number of years will keep you out of the AMT — or at least reduce the impact. In this case an installment sale might be an attractive alternative. But suppose your gain is so large that it will phase out your AMT exemption amount many times over. In this situation, you may get a better result by reporting all the gain in one year, so you're only affecting one year's exemption amount.
Timing other items
Another way to plan for the AMT is to see if you can change the timing of other items that are affected by the tax. For example, if you make estimated payments of state income tax, you may try to schedule your payments so they don't fall in the same year as your large capital gain. In some cases you may come out ahead even if you incur a small penalty for being late with your state estimated payment.