Taxable and Tax-Deferred Investing with the Limited Use of Losses
Review of Finance 21(5), 1847-1873 (2016)
32 Pages Posted: 19 May 2013 Last revised: 29 Sep 2017
Date Written: June 16, 2016
We study the impact of the different tax treatment of capital gains and losses on the optimal location of assets in taxable and tax-deferred accounts. The classical result of Black (1980) and Tepper (1981) suggests that investors should follow a strict pecking-order asset location rule and hold those assets that are subject to the highest tax rate preferentially in tax-deferred accounts. We show that with the different tax treatment of realized gains and losses, only tax-efficient equity mutual funds are optimally held in taxable accounts whereas mutual funds with average tax-(in)efficiency are preferentially held in tax-deferred accounts.
Keywords: portfolio choice, limited use of capital losses, tax-deferred investing, asset location
JEL Classification: G11, H24
Suggested Citation: Suggested Citation