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Abstract: 

The after-tax return on equities is negatively impacted by selling appreciated stock and recognizing capital gains. Even an investor who adopts a buy-and-hold strategy, inevitably will find it necessary to recognize capital gains at some point--due to such reasons as the need to rebalance a portfolio from equities to fixed income or to sell a stock with an outsized position in the portfolio in order to reduce risk, or because an appreciated stock has been acquired for cash by another company. While capital losses may be used to offset capital gains, in a period of rising stock prices, capital losses will often be insufficient to offset capital gains. A strategy that sophisticated investors might employ to address this problem is to use short sales to increase the likelihood of having sufficient capital losses to offset capital gains. This would be done while still maintaining a 100 percent net long position. This article explains the mechanics of this strategy and why it might be viable.

Keywords: tax efficiency, short sales, long/short portfolio, capital gains, capital losses

Affiliations:  1: Washington State University.