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 under current U.S.\ tax law. As 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 of using potential future losses against a higher tax rate. This incentive adds an entirely new and so far unstudied dimension to the portfolio problem. We show that it affects the distribution of public capital gain tax revenues and can explain the low empirically observed equity holding period.

Number of Pages in PDF File: 39

Keywords: asset allocation, portfolio choice, tax-timing, tax loss carry-forward

JEL Classification: G11, H24

Accepted Paper Series