Sell Those Shares Now or Wait? A Little
Math Can Help You Decide
By KATHY M. KRISTOF
Is it time to lock in your profits?
Investors who are sitting on shares of some of the highest-flying
technology stocks are doubtless weighing this tricky question.
After all, if you were lucky enough to buy Qualcomm Inc. stock
in January, for example, you probably paid around $30 (after
accounting for stock splits) for your shares. Recently, these same
shares were selling for around $384. Meanwhile, some of the
analysts who were touting the stock when it was selling for less than
40 times trailing per-share earnings are now beginning to question
whether Qualcomm is still worth owning when it's selling for more
than 150 times earnings.
But if you own the stock--or any other huge gainer--in a taxable
account and you haven't held it for at least a full year, you'd be wise
to include a little tax math along with the other factors that go into
your sell decision--such as how you feel about the company's
future.
If you sell in less than a year, you get hit with federal tax at your
ordinary income tax rate, rather than the capital gains rate, which is
sure to be lower. Even if you're not in a high tax bracket, that
differential can cost you thousands of dollars.
And what if the stock price drops before your one-year
anniversary? You might still be better off waiting. Indeed, a
middle-income investor could suffer nearly a 10% decline in
Qualcomm's stock price before he'd be better off selling today and
paying the higher federal tax rate. Those with higher incomes--and
higher tax rates--could sustain even bigger paper losses on the
stock and end up even, after-tax, if they waited to get the lower
capital gains rate.
To illustrate the math to use when making the sell decision,
consider two hypothetical investors, John Average, who is in the
28% federal income tax bracket, and Gina Rocks, who is in the
36% bracket. They each bought 100 shares of Qualcomm stock
last January when it was selling for $28 a share.
Now Qualcomm fetches about $384 per share--leaving these
investors with an 11-month profit of about $356 per share.
What happens if they sell today? John would end up paying
$9,968 in federal income tax (28% of his $35,600 profit). But if he
waits two more months to sell--and the stock price holds up--he'd
pay just $7,120 tax (at the 20% long-term capital gains rate), or
$2,848 less.
But what if the stock price drops in the next two months? John's
Qualcomm stock could drop in price by $35 per share and he
would still end up ahead, after taxes, by waiting to claim the
long-term gain.
If he sells this week at $384, for instance, he would take home
$28,432 after paying $9,968 in tax on the $38,400 in sales
proceeds. If he waits and the stock drops to, say, $336, he would
pay $6,160 in capital gains tax (20% of the $30,800 gain) from the
$33,600 in sales proceeds and still walk away with $27,440.
What about Gina?
Qualcomm's stock would have to drop to about $313 before
she'd be better off selling now versus waiting for the lower capital
gains rate.
If she sells now, she'd pay $12,816 in federal tax--that's 36% of
her $35,600 gain--and go home with $25,584 after tax. (That's the
net sales proceeds of $38,400 minus the $12,816 in tax.) If she
sells at $313 in February, she'd pay just $5,700 in federal capital
gains taxes, and go home with $25,600.
How do you figure that break-even point?
To do it right requires high school algebra that most investors
have long forgotten. But for the nostalgic, here's the formula: Your
break-even sales price equals the net after-tax sales proceeds
(assuming you're paying tax at ordinary income tax rates) minus the
product of the long-term capital gains rate times your tax basis in
the stock, divided by the inverse of the capital gains rate.
You followed that, right?
If not, you can estimate the number by comparing the per-share
tax hit if you sell now versus later (after holding for a year),
assuming that the company's stock price stays constant. With Gina,
for example, her capital gains rate is 16 percentage points lower
than her ordinary income tax rate. Multiply that by her taxable gain
in the stock ($356 per share) and you get a difference of about $57
per share. Consequently, she could take up to a $57-per-share loss
on the stock and still end up ahead after tax if she waits to get the
lower long-term capital gains tax rate.
This method understates the real impact of waiting if the stock
price drops in the interim, because the lower the stock price, the
lower your capital gain, the lower your federal tax. But it's a far cry
simpler for those who prefer a back-of-the-envelope calculation to
algebra.
* * *
Times staff writer Kathy M. Kristof can be reached at
kathy.kristof@latimes.com or at Business Section, Los Angeles
Times, Times Mirror Square, Los Angeles, CA 90053.
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