Could Long-Term Capital Gains Selling Be Weighing On The Market?

The SPDR S&P 500 ETF Trust SPY has generated a 78.1% total return since the stock market bottomed on March 23, 2020. Investors who bought the dip are now sitting on some big gains, and the one-year anniversary of the shortest bear market in history could generate some selling pressure in the market in the coming weeks.

Capital Gains Tax Rules: Profits from stock trading are taxes differently depending on how long the positions were held.

Capital gains from a stock that is held for less than a year before it is sold are considered ordinary income and are taxed accordingly. Therefore, an investor’s short-term capital gains tax rate depends on his or her tax bracket. For the 2020 tax year, the short-term capital gains tax rates for single filers are included in the table below.

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The capital gains taxes for long-term investors are much simpler and much more generous. For Americans earning up to $40,000, the long-term capital gains tax rate is 0%. For Americans earning between $40,000 and $441,450, the rate is 15%; and for those earning above $441,450, the rate is 20%.

An investor must wait to sell a stock until one day after the same calendar date the stock was purchased for the profits to be classified as long-term capital gains. For example, a stock purchased on March 24, 2020, and sold on March 24, 2021 is still classified as a short-term investment. If the stock is sold on March 25, 2021, the gains are classified as long-term and taxes accordingly.

Tax-Related Selling Pressure? An investor who bought $100,000 of Apple, Inc. AAPL on March 24, 2020, is now sitting on a profit of about $118,000. If that investor earns an income of $35,000, he or she would potentially owe $14,160 in capital gains taxes if the Apple shares are sold on March 24, 2021. If the investor waits another day and sells on March 25, he or she will owe $0 in capital gains taxes.

There are presumably a lot of investors who either added to their holdings or invested for the first time at or near the March 23, 2020 market bottom. However, many of those investors that have wanted to cash out their profits have likely waited until they reach the one-year mark to do so to avoid paying short-term capital gains taxes.

Benzinga’s Take: So far, the one-year mark hasn’t triggered a large degree of selling. However, if the S&P 500 comes under pressure in the coming weeks, tax-related selling could be a potential contributing factor behind the weakness.