Many investors take care to wait for a gain to become long-term before selling. By doing so, they benefit from the relatively low 15% capital gains tax. Here we take another look at when to sell stock.
Delay recognition of all capital gains, even long-term gains
Once the market value of a stock position rises above its cost basis, an investor has an unrealized gain. When she sells the stock, she will realize the gain and incur a capital gains tax.
In November 2009, she had an unrealized $10,000 long-term gain. Rather than recognizing that gain in 2008, she waited until February 2010 to sell the stock position.
She has delayed a $1,500 tax, $10,000 times 15%, by one full year: April 2010 to April 2011. By postponing the tax, she can invest the $1,500 for a year and earn $75, assuming a 5% return.
Unrealized gains are even more valuable
An unrealized gain is subject to a potential, future tax. Just when that tax becomes payable is at the discretion of the investor.
The ultimate purpose of investing is to preserve wealth over time. An investor need not sell an unrealized gain. By holding the gain, the gain will compound its return and grow like a tax-deferred account, such as an IRA.
In a sense, the investor can enjoy the benefit of the compounding effect of unpaid deferred tax. If and when she needs to withdraw the money from the portfolio, she may choose to realize the gain. For many investors, that day will come during retirement.