When Lockup's Over, Factor Taxes Into Your Sell Decision

Capital gains taxes can take a big chunk of your gains if you sell immediately after your stock's six-month lockup ends.
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Sell? Hold? What's a stockholder to do?

If your stock's coming out of a lockup, you are now free to sell. But before you do, spend a minute thinking about your tax bill. Assuming the stock has done well, the minute you sell, you could owe capital gains tax on as much as one third or more of your profits.

So before beefing up your tax bill, consider two things: your holding period and your break-even point.

The holding period is the time you've held the stock. Start counting the day you purchased it. The typical lockup period is six months. If you sell a stock you've held less than 12 months your capital gains will be taxed at your ordinary income tax rate. That could range from 15% to 39.6%, depending on your income. (To get a ballpark of your tax rate, check out the

1998 tax tables.)

But if you hang on to your stock for 12 months and a day, any gain generated from a sale will be taxed at the long-term rate of 20% (or 10% if you are in the lowest, 15% tax bracket).

So even though your six-month holding period has ended, it may be worth hanging on to it another six months and a day to get the lower capital gains rate.

On the other hand, your stock could fall in value during that period, potentially wiping out the tax savings -- and then some. So how do you decide whether to sell or hang on?

Start by figuring out your break-even point.

Let's assume you're sitting on an 80-per-share gain and you're in the 31% ordinary income tax bracket. In a very simple world, if you sold today, you'd only take home 55 per share, after taxes. If your 80-point gain holds until you hit a long-term holding period, you would take home 64 instead.

But if the stock price falls, there is a break-even point at which the short-term and long-term profits, after taxes, are the same. It is only when the stock's gain is above the breakeven point that you would be better off, tax-wise, if you held out for the long term.

Without a crystal ball, you'll have no idea in advance whether your stock will cross the break-even point. But at least you can determine how much of a cushion you have and factor that into your decision.

For instance, if you decide to hold the stock for the long-term and the gain falls to 70, your profit drops to 56. That's OK. You're still better off than if you took the short-term gain. (Of course, this doesn't take into account gains you might have made by selling immediately and investing the money elsewhere.)

But what if your gain drops to 68? Your profit is now 54. And in that situation, you might have been better off selling in the short term.

If your ordinary tax bracket is higher, say 39.6%, your stock has more room to fall before you hit your break-even point. On the flip side, if you're in a lower ordinary income tax bracket, you don't have as much room.

Here's simple chart of the possibilities for an imaginary stock that gained 80.

None of this insulates you from making the most important judgement: Do you think your stock's price is more likely to rise or fall? Ultimately, that should be the biggest factor in your decision -- not the taxes.