How to Decide When to Sell in Taxable Accounts

Many people with appreciated investments often are in a conundrum. The price reaches a point where there isn’t a margin of safety. But the investors are hesitant to sell because they know part of their gains will be reduced by taxes. Here are a couple of ways to make the decision. Compute what the taxes would be if the investment were sold, and then determine the percentage of the invest- ment’s current market value that the taxes would be. Compare that cost to the potential market risk of not selling.

For example, Max Profits owns a stock worth $100,000 that he pur- chased years ago for $10,000. His long- term capital gain is $90,000. If he sold, he would be in the 20% capital gains tax bracket and would owe $18,000 in taxes. That is 18% of the current mar- ket value and would be his guaranteed “loss” to taxes if he sold.

If Max believes there’s a reasonable probability the stock will decline more than 18% and the decline won’t be temporary, then it makes sense for Max to sell now, pay the tax and invest the remaining $82,000 in another invest- ment or hold it in cash. But if Max thinks there’s a low risk of a greater than 18% sustained price decline, then the tax cost is more than the market risk.

Another way to evaluate the issue is to look at investment alternatives. Suppose Max believes the investment is fully valued or overvalued. He would take an 18% tax loss to exit the invest- ment. He should consider how long it would take other investments to make up that 18% loss, plus whatever additional appreciation or income he estimates he would have earned from continuing to hold the stock.

There’s uncertainty in these meth- ods, because we don’t know the returns each of the investments will generate. But this process requires us to consid- er the key factors in the decision and take hard looks at both the current and potential investments.