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Capital Gains Tax Increase - why you should not realize gains in 2012

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Dec 30, 2012 2:48 am

I've seen many financial pundits advocating a strategy of selling appreciated stocks before the end of 2012 and immediately buying the stocks back.  This sale and repurchase is done in order to pay 15% federal cap gains tax (vs. 20% beginning in 2013).  I don't think this makes any sense for most buy and hold investors.  The issue I see is that any tax savings achieved is quickly outweighed by the negative consequences of paying taxes on 2012 sales.  By paying taxes for 2012 sales, an investor removes the amount paid in taxes from their investment portfolio and therefore looses the benefit of continued appreciation of that amount.  Within a few years, the compounded appreciation on the amount paid to taxes would more than offset the additional taxes paid (assuming capital gains tax rates rise from 15% to 20%) when the securities are finally liquidated.

For example, assume an investor has individual stocks worth $100,000 with a cost basis of $25,000.  This investor can do one of two things:

1: Sell before the end of 2012 and pay a 15% federal capital gains rate, or

2: Continue to hold the stocks and pay a 20% federal capital gains rate when the stocks are sold in the future.  

Assuming this investor's stocks appreciate 8% annually, option 2 will have an aftertax value exceeding option 1 beginning in year 5 ($122,546 vs. $122,072).  The difference is more pronounced the longer the investor holds the stocks.  By year 25, the after-tax difference between each strategy is approx. $50,000.  Thus it seems to me that for most buy and hold investors, selling in 2012 in order pay a 15% capital gains tax rate is not a good strategy.

Does anyone else have thoughts on this?