Capital Gains Tax Rules, Tax Loss Trading and Turn-of-The-Year Returns

40 Pages Posted: 25 Apr 1999 Last revised: 10 Oct 2010

See all articles by James M. Poterba

James M. Poterba

National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Department of Economics

Scott J. Weisbenner

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: June 1998

Abstract

This paper investigates the effect of specific features of the U.S. capital gains tax on turn-of-the-year stock returns. It focuses on two tax changes. The first, enacted in 1969, reduced the fraction of long-term losses that were deductible from Adjusted Gross Income from 100 percent to 50 percent. The second, part of the Tax Reform Act of 1976, raised the required holding period for long-term gains and losses from six months to one year. This paper describes how each of these tax changes should have affected incentives for year-end capital loss realization and the potential magnitude of the turn of the year effect in stock returns. We present evidence that is consistent with the hypothesis that detailed provisions of the capital gains tax, such as the short-term holding period, affect the link between past capital losses and turn-of-the-year stock returns. These findings provide support for the role of tax-loss trading in contributing to turn-of-the-year return patterns.

Suggested Citation

Poterba, James M. and Weisbenner, Scott J., Capital Gains Tax Rules, Tax Loss Trading and Turn-of-The-Year Returns (June 1998). NBER Working Paper No. w6616. Available at SSRN: https://ssrn.com/abstract=160537

James M. Poterba (Contact Author)

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Scott J. Weisbenner

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