# Value of Capital Gains Tax Deferral



## Park (Sep 11, 2010)

One advantage of long term investing is the ability to defer capital gains, and thereby defer tax. Until I saw this post, I never had seen an analysis of the increased return associated with deferral of capital gains. 

https://www.kitces.com/blog/whats-t...ng-capital-gains-less-than-most-people-think/


The author in the link makes the case of a $300 K investment that has appreciated to $400k. Assume a 15% capital gains tax rate. By deferring capital gains, you defer tax of $15,000 every year. So the government has given you an interest free loan of $15,000. You invest that $15,000, and assume you get an 8% return on that $15,000. 8% of $15,000 is $1,200 yearly. So by deferring capital gains, you make an extra $1,200 on your $400K, which works out to an increased return of 0.3% annually.

The value of the capital gains tax deferral will depend on the return you obtain on the government's interest free loan. It will also depend on your tax bracket. The higher the tax bracket, the greater the benefit from the capital gains deferral. It will also depend on how much the asset has appreciated. The more an asset has appreciated in value, the greater the benefit of capital gains deferral.

Near the end of the post, he provides the table below:

Appreciation	15% tax rate	23.8% tax rate
10% 0.109%	0.173%
20%	0.200%	0.317%
30%	0.277%	0.439% 
40%	0.343%	0.544%	
50%	0.400%	0.635%
60%	0.450%	0.714%
70%	0.494%	0.784%
80%	0.533%	0.846%
90%	0.568%	0.902%
100%	0.600%	0.952%

He doesn't give the assumed rate of return on the deferred tax, but based on his example, it looks like it's 8%.

The 23.8% tax rate is relevant to the marginal tax rate of a good number of investors, as is an 8% return on the deferred tax. Assume an 8% return on the original investment. In 3 years, your appreciation is 26%. For 5 and 10 years, the corresponding appreciation is 47% and 116%. 

The numbers are less than I thought they would be.


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## atrp2biz (Sep 22, 2010)

This is why there are those (including myself and HP) that vouch for non-dividend paying holdings outside of registered plans. Dividends are taxable events. They also aren't free money. A company is not paying you dividends. You are paying yourself dividends and the company and its management is the intermediary, so why pay taxes on it? I'm happy to be a long-term buy-and-hold investor of quality non-dividend equities (eg. BRK) to defer taxes as long as possible.


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## Eclectic12 (Oct 20, 2010)

... which is fine until one decides to buy a Tier 1 Canadian Bank ... all of which pay dividends.

Choosing only works when there's a choice ... :biggrin:


Cheers


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## warp (Sep 4, 2010)

You overlook one small detail....

If you hold onto these gains for many, many years, you may end up with a very large capital gain, on your books.

At some point all these gains will be added to your income...up to and including the year you die, ( or your spouse dies, after you go). This will result in one huge tax bill.

Several posters on here have said they take some capital gains every year and pay the smallish taxes, then buy back and raise their cost base. I'm not saying which is better....but it is worth thinking about.


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## atrp2biz (Sep 22, 2010)

The after tax value is still higher when you defer taxes to the end. Here's the math:

[[(1 + r)^n - 1] x (1 - t)] + 1 > [1 + (r x (1 - t))]^n

, where r = annual rate of return; t = tax rate; n = investment horizon in years

Also, one's marginal tax rate is typically lower in the non-working years and the gains can be realized at the back end.



> _Several posters on here have said they take some capital gains every year and pay the smallish taxes, then buy back and raise their cost base. I'm not saying which is better....but it is worth thinking about._


Face palm.


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## humble_pie (Jun 7, 2009)

face palm? the way i see it, it's only a face palm if income truly does go down in the post-salaried retirement years.

but what if income rises? there are many events that can bring this about. Sale of a business, sale of a house, sale of a practice, inheritance, good portf management over a lifetime, etc.


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## atrp2biz (Sep 22, 2010)

I get that. There are other factors that would make taking capital gains earlier. But it doesn't make sense if the only reason for taking the capital gains on an annual basis is to pay smallish taxes every year as opposed to a big one later on (all things being equal). One can also control when those gains are realized. You obviously wouldn't take them during years of major events you mention above.


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## humble_pie (Jun 7, 2009)

here's a wrinkle that i've mentioned once before, but not a creature stirred, not even a mouse. A small handful of alberta-based energy companies have introduced a new form of DRIP dividend. Investor doesn't receive any cash at any time, merely receives new shares & new fractionals as the dividend payment. 

these are to be used to write down the cost base. Eventually, upon disposition, they will be taxed as capital gains. As atrpdocbiz has shown, this is the most favourable form of investment income, outstripping dividends even after dividend tax credits have been taken into account.

no T5s are issued for these capital DRIP dividends, so there are no dividends to declare as such on tax returns. This approach is useful for 1) parties facing AMT taxes; 2) parties facing clawbacks of old age benefits; or 3) any persons who suffer regularly from TDA (taxable dividend anxiety.)

among this handful of alberta energies with the novel dividends are Husky & Arc Energy. I don't know husky, but Arc tells me that CIBC is the only broker that will cooperate with their new dividend plan. ARX shareholders at other brokers who wish to enrol in Stock Dividend Drips must set up accounts registered in their names directly with the transfer agent, which is computershare. ie one would buy shares at a broker, get them registered in one's name & transferred over to computershare for a fee generally in the neighbourhood of $50, although questrade's fee for this service is reportedly $200.


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## humble_pie (Jun 7, 2009)

(a folk tale for atrpdocbiz) (imagine selling calls against long stock held at computershare) (options have to be done at the broker)

(not a problem, one can sell naked calls at the broker) (oops) (a few contracts get assigned) (this means stock has risen)

(one could collect enough shares to cover from computershare) (but all in all it would be easier to go buy the covering shares on the open market while leaving the computershare holding intact) (all this would be a taxable event, though)



)


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## My Own Advisor (Sep 24, 2012)

Funny stuff HP 

I love dividends (and the dividend tax credit) but when it comes to deferring taxes in non-registered accounts I like capital gains even more!


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## atrp2biz (Sep 22, 2010)

Leçon du jour: Close the option position prior to assignment. If the option is deep ITM going into the last two weeks prior to expiry, just close it.


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## humble_pie (Jun 7, 2009)

(i was thinking only of early assignments) (the rare ones that occur because of reorgs, warrants, takeovers, etc) (they are the ones that can't be predicted)

(dividend early assignments can mostly be predicted & avoided) (but the exotic reorgs can be sneaky)


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## atrp2biz (Sep 22, 2010)

(so if you can't predict it) (why worry about it) (i'm only talking about voluntarily incurring capital gains) (to invoke a taxable event) ((which doesn't make sense to me))


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