Optimal Tax-Timing and Asset Allocation when Tax Rebates on Capital Losses are Limited

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

This article studies the portfolio problem with realization-based capital gain taxation when limited amounts of losses qualify for tax rebate payments, as is the case under current US tax law. When the tax rate applicable to realized losses exceeds that on realized capital gains, it can be optimal to realize capital gains immediately and pay capital gain taxes to regain the option to use potential future losses against a higher tax rate. This incentive adds an entirely new and as yet unstudied dimension to the portfolio problem. It causes risk averse investors to hold more equity and attain higher welfare levels than is the case when trading under a tax system that seeks to collect the same amount of taxes, but does not allow for tax rebate payments. This is because the benefit to these investors from having their losses subsidized is greater than the suffering from having profits taxed at a higher rate.
Original languageEnglish
JournalJournal of Banking & Finance
Volume36
Issue number7
Pages (from-to)2048–2063
Number of pages16
ISSN0378-4266
DOIs
Publication statusPublished - 2012

Keywords

  • Capital Gain Taxation
  • Tax Rebate Payments
  • Limited Use of Losses
  • Portfolio Choice

Cite this

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title = "Optimal Tax-Timing and Asset Allocation when Tax Rebates on Capital Losses are Limited",
abstract = "This article studies the portfolio problem with realization-based capital gain taxation when limited amounts of losses qualify for tax rebate payments, as is the case under current US tax law. When the tax rate applicable to realized losses exceeds that on realized capital gains, it can be optimal to realize capital gains immediately and pay capital gain taxes to regain the option to use potential future losses against a higher tax rate. This incentive adds an entirely new and as yet unstudied dimension to the portfolio problem. It causes risk averse investors to hold more equity and attain higher welfare levels than is the case when trading under a tax system that seeks to collect the same amount of taxes, but does not allow for tax rebate payments. This is because the benefit to these investors from having their losses subsidized is greater than the suffering from having profits taxed at a higher rate.",
keywords = "Capital Gain Taxation, Tax Rebate Payments, Limited Use of Losses, Portfolio Choice",
author = "Marcel Marekwica",
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language = "English",
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}

Optimal Tax-Timing and Asset Allocation when Tax Rebates on Capital Losses are Limited. / Marekwica, Marcel.

In: Journal of Banking & Finance, Vol. 36, No. 7, 2012, p. 2048–2063.

Research output: Contribution to journalJournal articleResearchpeer-review

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AU - Marekwica, Marcel

PY - 2012

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AB - This article studies the portfolio problem with realization-based capital gain taxation when limited amounts of losses qualify for tax rebate payments, as is the case under current US tax law. When the tax rate applicable to realized losses exceeds that on realized capital gains, it can be optimal to realize capital gains immediately and pay capital gain taxes to regain the option to use potential future losses against a higher tax rate. This incentive adds an entirely new and as yet unstudied dimension to the portfolio problem. It causes risk averse investors to hold more equity and attain higher welfare levels than is the case when trading under a tax system that seeks to collect the same amount of taxes, but does not allow for tax rebate payments. This is because the benefit to these investors from having their losses subsidized is greater than the suffering from having profits taxed at a higher rate.

KW - Capital Gain Taxation

KW - Tax Rebate Payments

KW - Limited Use of Losses

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