Tax Drag under CG Tax

CFA Level III
#1

Hey all,

With CG Tax, the Tax Drag % is said to = Tcg, even when Return or Time Horizon fluctuate.

It seems to me that this relationship holds only when the Basis = 1

If Basis = let’s say 0.75, it seems to me that the relationship doesn’t hold anymore.

Thoughts ?

#2

Basis decreases - you would pay more tax, so tax drag would increase.

#3

agreed, if CG taxes are applied on a deferred basis & cost basis = mv…Tcg % = Tax drag %

if cost basis decreases, it would result in Tax drag % slightly greater than Tcg %

#4

Tax drag % can be lower than tax rate. Right?

#5

how thru tax loss harvesting?

I dont think so it should be atleast equal to tax rate…

#6

Simple way to answer this is just plug in numebrs.

Assume: N=20, R = 10%, Tax Rate CG = 30%

If basis = 100%, the Tax Drag $ = 1718.25, or 30%

If basis = 75%, tax drag = $1793.25, or 31%

So if basis is ess than 100%, tax drag will increase. This makes snese intuitively, because you will owe more tax.

#7

Sorry guys, maybe my question should have been a little more clear.

What I meant was that with a CONSTANT Basis of less than 1, making Return or Time Horizon fluctuate changes the Tax Drag % when I compute it.

I was confused because Schweser says that Tax Drag % is constant and = Tcg regardless of Return or Time Horizon, with no mention of the Basis.

#8

if tax basis = 1, then tax drag = tax rate for deferred cap gains no matter the return or time horizon

#9

…and when Basis < 1, what happens with TaxDrag % when you play with R and Time Horizon ???