A blog about stock portfolio management

Holding a capital loss until long-term could be costly

April 09, 2010

Holding onto a short-term capital gain until it becomes long-term can save a lot of tax. This does not hold true with a short-term loss.

A mix of realized gains year to date

An investor already has $10,000 of realized capital gains. Half of these gains, $5,000, are short-term and half are long-term. Subject to the top marginal tax rate, the short-term gains would incur a tax of $1,750 ($5,000 times 35%). The tax on the long term-gains, using the 15% rate, would be $750 ($5,000 times 15%).

Overall, she expects to pay a tax of $2,500, on gains totaling $10,000.

Realizing a long-term loss

Thirteen months ago she bought 300 shares of stock at $40. The stock price has since dropped to $30. Her $12,000 investment has lost 25% of its value and is now worth $9,000.

If she sells the stock, she will realize a $3,000 long-term loss ($12,000 - $9,000). Added to her other long-term gains, the loss will lower her long-term gains to $2,000 for the year. The tax on the long-term gains would drop to $300 ($2,000 times 15%).

As the capital gains tax now totals $2,050, taking the loss has saved her $450.

Better yet: take an earlier short-term loss

Six weeks earlier, that same stock had a price of $30. She was already holding a short-term loss. Had she sold the stock at that time, she would have realized a $3,000 short-term loss. This loss would have offset the other short-term gains, rather than the long-term gains. With the total short-term gain now just $2,000, its tax would have fallen from $1,750 to just $700.

Her total capital gains tax would have been $1,450 ($700 plus $750). By taking this loss earlier, she would have saved $1,050 in tax.

Why waste the tax savings of a loss by offsetting a long-term gain?

Taking a long-term loss, rather than a short-term loss, missed a chance to save $600 in tax. This happened because a short-term loss has its highest value when it offsets other short-term gains or ordinary income. After it becomes a long-term loss, it will first offset any long-term gains. Since these gains already benefit from a lower tax rate, the offset is worth less.

Tags: capital-gain and tax