*Here’s an encore presentation of a HOT: Homa Online Tutorial originally posted before the election.*

* * * * *

Well, Obama got his dream to come true — capital gains rates have been jacked from 15% to 23.8% …. the basic capital gains tax rate went from 15% to 20% … and ObamaCare has a 3.8 non-payroll payroll tax on investment income starting in 2013.

So, the effective capital gains tax rate goes from 15% to 23.8% … a delta of 8.8%.

**That 8.8% tax rate increase will cut after-tax capital gains ROIs.**

By how much?

**Answer: The pre-tax ROI times 8.8%.**

**Here’s the math …**

In other words, the answer depends on the proportion of a stock’s value that is unrealized capital gains.

The answer isn’t intuitive and the math is a bit hairy, so let’s run thru an example ….

* * * * *

**Scenario 1 – CG Tax = 15%**

Assume that you bought a stock for $750 and sold it for $1,000 … netting a **$250 pre-tax gain**.

The **pre-tax ROI** is **33%** … $250 divided by $750.

If the capital gains tax is **15%**, you pay** $37.50** in taxes … netting you, after taxes, **$212.50**.

The **after-tax ROI** is **28.3%** … $212.50 divided by $750.

* * * * *

**Scenario 2 – CG Tax = 23.8%**

Again assume that you bought a stock for $750 and sold it for $1,000 … netting a **$250 pre-tax gain**.

The **pre-tax ROI** is still **33%** … $250 divided by $750.

If the capital gains tax is **23.8%**, you pay **$59.50** in taxes … netting you, after taxes, **$190.50**.

The **after-tax ROI** is **25.4%** … $190.50 divided by $750.

* * * * *

**The Difference**

The **CG-ROI @15%** is **28.3%**, where** CG**-ROI @ 15% is the Capital Gains ROI at a 15% Tax Rate.

The **CG-ROI @23.8%** is **25.4%,** where CG-ROI @ 23.8% is the Capital Gains ROI at a 23.8% Tax Rate

The difference is **2.9%** … that is, **the CG-ROI dropped by 2.9 percentage points**.

Note that 2.9% is **equal to the pre-tax ROI (33%) times the difference in the tax rates (8.8%)**

* * * * *

**The generalizable answer**

By math magic, **the difference in after tax ROIs** **are always** **equal to the pre-tax ROI** (which varies depending on the relationship between a stock’s unrealized capital gains and its cost basis)** times the difference in the tax rates** (in this case, the 8.8% difference between 15% and 23.8%).

If you’re interested, click to view the math work … if you’re not, skip to the table below.

Here’s a handy look-up table.

UR-CG are unrealized capital gains as a percentage of current stock market value.

In the above example, UR-CG equals 25% … $250 pre-tax capital gains divided by stock’s current market value $1,000 … and there’s a 2.9 percentage point drop in ROI.

As you’d expected, the greater the percentage of capital gains embedded in a stock, the greater the ROI hit if marginal tax rates go up.

* * * * *

**So what?**

Those are serious drops in ROIs and – contrary to Buffett’s “only look at pre-tax” rule — it’s why many investors accelerated asset sales into 2012.

In a subsequent post I’ll work thru the math re: whether that makes sense.

** * * * *
*

**Follow on Twitter***@KenHoma*

**>> Latest Posts**
## Leave a Reply