Avoiding Short-Term Capital Gains by Tara Thompson Popernik, AllianceBernstein.
Want to reduce tax on your investment income? Avoid sales of appreciated stocks held less than a year. Here’s how it might have helped some disappointed Facebook Inc (NASDAQ:FB) shareholders earlier this year.
First, the rules: Capital gains on the sale of stocks held for more than a year are taxed at a lower, long-term capital gains rate than gains on the sale of stocks held a year or less. By waiting to sell a position at a gain until it has been held for more than a year, a top-bracket taxpayer can reduce the tax bite from 43.4% to 23.8%. Investors in lower tax brackets who wait sometimes can entirely eliminate the tax on a capital gain.
The benefit of waiting to sell can be large, even if the stock declines significantly while you’re waiting. Let’s say an investor in the top tax-bracket bought Facebook shares near its all-time low on March 27, 2013, for $25 a share, and almost a year later, still held the stock.
Her gain would be huge. At its 52-week high, on March 11, 2014, Facebook was trading for $72.59, almost three times its IPO price. That might have made it tempting to sell—but there were still more than two weeks to go until the gains realized on the holding would become subject to long-term, rather than short-term, capital gains tax.
If the investor sold at the high, she would realize a sale price of $72.59 but would owe 43.4% tax on a $47.59 short-term gain. A tax bill of over $20 would net her only $51.94 per share.
If she held onto the stock for a few weeks longer, she might lose some of the embedded gain—but she would get much more favorable tax treatment of the gain. Even if the stock dropped 15%, she would garner greater after-tax proceeds by waiting for the stock to be subject to long-term capital gains tax than by selling at the high.
Assuming that the investor sold the position at the opening price on the day it became subject to long-term capital-gains taxation (March 28, 2014), she would realize a sale price of $61.34, about $11 below the high. But by reducing her tax to the long-term capital gains tax rate, she would net $52.69, or 1.4% more than if she sold at the top (Display).
Of course, the opposite could have occurred. The position could have increased in value while she held the stock for long-term-gain treatment, so that she could have saved in taxes and earned a higher gross return.
As the Facebook example shows, it’s not what you receive that matters, but what you get to keep.
Timing transactions may sound easy, but it can be complicated, particularly for investors with large, diversified portfolios divided among multiple accounts.
While timing transactions may sound easy, it can be complicated, particularly for investors with large, diversified portfolios divided among multiple accounts.
The views expressed herein do not constitute, and should not be considered to be, legal or tax advice. Please consult with your legal or tax advisor regarding your specific situation.
Tara Thompson Popernik is Director of Research in the Wealth Planning & Analysis Group at Bernstein Global Wealth Management, a unit of AllianceBernstein (NYSE: AB).