Monday, January 30, 2012

15% Capital Gains Tax Myth

Just for a little perspective I made a quick graph showing the true capital gains tax rate adjusted for inflation. To make the math simple let's assume you invested $100 in a stock and it doubled in value to $200 so the capital gains taxes owed would be 15% * ($200-$100) = $15. If you use a 2.5% inflation rate you're $200 investment is actually only worth $195 after 1 year. You taxes stay the same at $15 but is being taxed in reality on $95 ($195 - $100) meaning your actual capital gains tax rate is 15.8%. If we go out to year 2 your inflation adjusted investment is worth $190.13 but you still pay the $15 in taxes giving you an adjusted capital gains tax rate of 16.6%. See chart below assuming 2.5% inflation rate.



Of course this is assuming just a 2.5% inflation rate, if you're saving to cover college costs or health care costs the actual inflation rate is closer to 7% on the low end. After 2 years you would be paying a 20.6% capital gains tax. So what does this mean? Well I don't have any faith that the government can overhaul the tax code to make it a lot simpler like I would prefer. And they do like to make things complicated so maybe they should add an inflation adjustment to the tax rate. I don't see either of these happening but it does add a new piece of information to help determine sales on stocks that run too far too fast. I have several positions as you'll see in my next portfolio update that have gains of 10-20% over a very short time period. Most of these are financials which I expected to see but nowhere near this fast. I think this is definitely another knock against buy-and-hold investing and another plus for buy-and-monitor.

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