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How to Decide When to Take Taxable Gains

Last update on: Jun 16 2020

Investors have a tax conundrum as we approach the end of 2019.

Major U.S. stock indexes are hitting record highs. Bonds had a strong run in 2019. Gold has been a strong performer as well. Owners of some individual stocks and other assets have substantial paper gains.

But the outlook is shaky to many people. Investors are wondering if they should sell investments with big gains, pay the taxes and pocket the after-tax profits. Or does it make sense to hang on through any market correction or even a bear market? Here’s an analysis I recommend for this situation.

Basically you want to compare the potential investment loss from a market decline to the certain tax loss if you sell.

First, determine what the taxes would be if you sell today. Second, compute the percentage of the current market value the taxes would be.

Finally, compare that tax loss from selling to what you think is the potential market risk of not selling.

For example, Max Profits owns a stock he purchased years ago for $10,000 that has a current value of $100,000. His long-term capital gain is $90,000.

Max is in the 15% long-term capital gains bracket. If he sold, he would owe $13,500 in taxes. That is 13.5% of the current market value and would be his guaranteed “loss” to taxes.

If Max believes there’s a high probability the stock will decline more than 13.5% and the decline won’t be temporary, then it makes sense for Max to sell now, pay the tax, and invest the remaining $86,500 in another investment or hold it in cash. But if Max thinks there’s a low risk of a greater than 13.5% sustained market decline, then the tax cost is larger than the market risk.

This is an extreme example, because Max’s tax basis is so much lower than the current value. The tax loss from selling would be much lower if Max’s gain wasn’t as high.

There are a couple of other factors Max might consider.

Suppose Max believes the investment is nearing a top that isn’t likely to be reached again for at least several years. He also believes it’s probable in the short term the investment will experience a correction or a bear market.

Max can look at his investment alternatives. If he sells and takes his 13.5% tax loss, he has $86,500 to invest in one or more other investments. The new investments would need a return of 15.61% to bring the value to $100,000, before taxes.

Max can consider how likely it is that other investments would generate that level of return and how long it would take. He could compare that to how long he thinks it would take the current investment to rebound to $100,000 after a correction.

This is an analytical way of asking whether you think any decline in the asset would be a permanent impairment of capital or a temporary loss. You know the tax loss from selling the investment would be a permanent impairment of capital.

Of course, it’s possible that Max has capital loss carryforwards or other tax benefits that would reduce or eliminate the capital gains tax from selling the stock. That makes the decision to sell easier.

Recent research shows that for most investors taxes take more of their investment returns than expenses and most other factors. To avoid giving the IRS too much of your hard-earned investment gains, conduct this kind of analysis. Compare the potential cost of holding the investment to the certain cost of selling it and paying taxes. Also, consider the potential gains of investing the after-tax proceeds in something else.


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Congress Comes for your Retirement Money
A devastating new law has just been enacted, with serious consequences for anyone holding an IRA, pension, or 401(k). Fortunately, there are still steps you can take to sidestep Congress, starting with this ONE SIMPLE MOVE.

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