Optimal tax-timing and asset allocation when tax rebates on capital losses are limited

Marekwica, Marcel

doi:10.1016/j.jbankfin.2012.03.011

Cited by 26 publications

(14 citation statements)

References 53 publications

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“…In contrast to the existing literature (e.g., Constantinides 1984;Dammon and Spatt 1996;Ehling et al 2010;Marekwica 2012), we find that it may be optimal for investors to defer not only short-term losses but also large long-term gains and long-term losses. Intuitively, different from what is assumed in the existing literature, the higher short-term rates apply to both long-term and short-term losses under the current law.…”

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confidence: 99%

“…3 For example, Cadenillas and Pliska (1999), Dammon, Spatt, and Zhang (2004), Gallmeyer, Kaniel, and Tompaidis (2006), Ben Tahar, Soner, and Touzi (2010), Ehling et al (2010), Marekwica (2012), and Fischer and Gallmeyer (2012). 4 As shown in DeMiguel and Uppal (2005), an investor rarely has more than one cost basis, and as shown in the Appendix, the certainty equivalent wealth loss from following a single-basis strategy (which is a feasible, but suboptimal strategy in our model) is almost negligible (to keep a single basis, one needs to liquidate the entire position before any additional purchases can be made).…”

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confidence: 99%

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Optimal Tax Timing with Asymmetric Long-Term/Short-Term Capital Gains Tax

et al. 2015

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We develop an optimal tax-timing model that takes into account asymmetric long-term and short-term tax rates for positive capital gains and limited tax deductibility of capital losses. In contrast to the existing literature, this model can help explain why many investors not only defer short-term capital losses to long term but also defer large long-term capital gains and losses. Because the benefit of tax deductibility of capital losses increases with the short-term tax rates, effective tax rates can decrease as short-term capital gains tax rates increase. (JEL G11, H24, K34, D91) Investors in U.S. stock markets are subject to capital gains tax when gains or losses are realized. When gains are realized, a lower long-term tax rate applies if and only if the stock holding period is at least one year. In contrast, when losses are realized, a higher short-term rate applies regardless of the length of the holding period, and investors effectively get a tax rebate. The short-term rate is set to investors' marginal ordinary income tax rate, and the rebate is implemented through deducting the losses from their taxable ordinary income. Assuming that a long-term tax rate applies to long-term losses, the existing literature on optimal investment with capital gains tax argues that We thank Pietro Veronesi (the Editor) and an anonymous referee for very helpful comments. We are grateful to

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Optimal Tax Timing with Asymmetric Long-Term/Short-Term Capital Gains Tax

et al. 2015

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“…Equation 22 simply guarantees for every investor that the bond does not dominate each stock from a post-tax perspective. Equation 23, that each stock price plus dividends can fall, is not necessary to rule out post-tax arbitrage, but greatly simplifies the arguments.…”

Section: Remark 3 (Extension To More General Price Systems)mentioning

confidence: 99%

“…For a study of portfolio choice with no wash sales, see Jensen and Marekwica [21]. The portfolio choice impact of the limited use of capital losses is studied in a single stock setting by Marekwica [22] and a multiple stock setting by Ehling et al [13].…”

Section: Introductionmentioning

confidence: 99%

Arbitrage and the tax code

Gallmeyer

Srivastava

2011

Math Finan Econ

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We provide a detailed characterization of arbitrage-free asset prices in the presence of capital gains and income taxes. The distinguishing feature of our analysis is that we impose on the model two important features of the tax code: the limited use of capital losses and the inability to wash sell. We show that under remarkably mild conditions, the lack of pre-tax arbitrage implies the lack of post-tax arbitrage with the limited use of capital losses. The conditions are that the risk free interest rate be positive and that tax rates on interest income exceed capital gains tax rates. The result also holds when only a wash sale constraint is imposed and no investor holds a portfolio with a large capital loss. We allow investors to face different tax rates and have different bases for the calculation of capital gains taxes. The characterizations we provide have important implications for both asset pricing and portfolio choice. Our results imply that models that use arbitrage-free pre-tax models continue for derivative pricing and hedging are also arbitrage free in a world with taxes. Similarly, portfolio choice models with taxes typically specify pre-tax arbitrage free price processes and then analyze portfolio choice in the presence of taxes. In these models, it is unclear if portfolio recommendations are based on risk-return tradeoffs or on the arbitrage opportunities present in the model. Our results imply that if the above features of the tax code are modeled explicitly, then we can isolate the post-tax risk-return tradeoffs.

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“…While the impact of the opportunity to invest in a tax-deferred account has been extensively studied Sialm, 1998, 2003;Dammon et al, 2004;Poterba et al, 2004;Garlappi and Huang, 2006;Huang, 2008;Gomes et al, 2009;Zhou, 2009), only limited guidance is available to investors who face tax systems where capital gains and losses are subject to different tax treatments. In a single taxable account setting, Marekwica (2012) and Ehling et al (2015) argue that a differential tax treatment of capital gains and losses can have a large impact on optimal portfolio choice.…”

Section: Introductionmentioning

confidence: 99%

Taxable and Tax-Deferred Investing with the Limited Use of Losses

Fischer

Gallmeyer

2013

SSRN Journal

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We study the impact of the different tax treatment of capital gains and losses on the optimal location of assets in taxable and tax-deferred accounts. The classical result of Black (1980) and Tepper (1981) suggests that investors should follow a strict pecking-order asset location rule and hold those assets that are subject to the highest tax rate preferentially in tax-deferred accounts. We show that with the different tax treatment of realized gains and losses, only tax-efficient equity mutual funds are optimally held in taxable accounts whereas mutual funds with average tax-(in)efficiency are preferentially * We would like to thank

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Optimal tax-timing and asset allocation when tax rebates on capital losses are limited

Cited by 26 publications

References 53 publications

Optimal Tax Timing with Asymmetric Long-Term/Short-Term Capital Gains Tax

Optimal Tax Timing with Asymmetric Long-Term/Short-Term Capital Gains Tax

Arbitrage and the tax code

Taxable and Tax-Deferred Investing with the Limited Use of Losses

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