What Determines Capital Gains Realization? Updated Evidence
In this paper, an empirical work is designed to test whether individual’s trading decision of stocks can be explained by taxation incentives. Based on the realization tax rule, taxes are incurred when investors actually sell their stocks and realize capital gains or losses, not when capital gains or losses are accrued. Constantinides (1983, 1984) argues that the realization tax rule provides a tax-timing option to an investor to realize losses whenever they are incurred but deferred gains to future time periods. However, tax rule and transactions costs prevent investors from exploiting this tax-timing option fully. This study attempts to directly test whether investors’ relevant tax status such as marginal tax rate and accumulated capital loss-carryover can affect an investor’s decision of realizing capital gains. Using the annual statistics provided by Canada Revenue Agency in year 2015, it finds that, consistent with the argument, an investor’s realized capital gains are negatively associated with his marginal tax rate, but positively associated with his capital loss-carryover.
Keywords - Capital Gains And Losses, Realization Rule, Tax-Timing Option, Marginal Tax Rate