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"Breakeven" point for taxation on short vs long-term stock investments?

Personal Finance & Money Asked by rinogo on November 29, 2020

Assume that Joe is in the 28% tax bracket. Sale of long-term (greater than 1 year) holdings is therefore federally taxed for Joe at 15%.

Joe can either buy and hold for one year (or more) to minimize taxes, or buy and sell much more frequently and hope to offset the increased taxes with increased gains.

Percentage-wise, how much “better” must Joe do with his short-term trading strategy than he can do with his long-term strategy in order to “break even”?

The knee-jerk calculation seems to suggest that Joe must do 13% better with his short-term strategy in order to “break even” against his long-term strategy. Is that correct?


Note: This is, of course, considering that all other things are equal between the two tax scenarios. Also, I’m likely ignoring a lot of nuances in this example – please make suggestions on how I need to tweak my question in order to get a fairly reliable answer.

For example, assuming Joe lives in Utah, the difference in “short vs long-term” state capital gains tax rates is 7% - 5% = 2%. Does this mean that Utah-resident Joe needs to actually do 15% “better”?

2 Answers

Assume that Joe is in the 28% tax bracket. Sale of long-term (greater than 1 year) holdings is therefore federally taxed for Joe at 15%. Percentage-wise, how much "better" must Joe do with his short-term trading strategy than he can do with his long-term strategy in order to "break even"?

Per the formula posted by hsane, Joe would have to do 18% better.

JTP's suggestion of "Don't let the tax tail wag the investing dog" is appropriate. You should be making your decision based on fundamentals not taxation.

I'm also in agreement with Quid. You shouldn't be trading short term unless you have an edge and that's something rare for a retail trader to find.

Let's assume that you intend to sell your stock. If the gain is large enough and the time until the one year mark is not too far away, you could utilize options to lock in a large part of the gain for less than the 18% of appreciation that you would have to achieve if you sold before the one year mark.

Answered by Bob Baerker on November 29, 2020

ratio is given by (1 - long_term_tax_rate)/(1 - short_term_tax_rate)

With 20% long term rate and 37% short term rate that ratio will be 1.27.

i.e. his short term gains need to be 27% more than his long term target.

Answered by hsane on November 29, 2020

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