Don’t forget tax implications when taking profits

Given the volatile market conditions that have prevailed in 2020, plenty of investors would have been trading in and out of the market.

Just as records have been broken in terms of withdrawals from superannuation funds, a much larger percentage of individual investors than is usually the case would have been cashing in their chips during the coronavirus crash.

It is often tempting to offload stocks where you are selling at a profit, but the longer-term implications can be disadvantageous.

When markets started to rebound in March, many of the stocks that had been abandoned rebounded sharply, often surpassing the levels they were sold down at even in the early stages of the crash.

Consequently, many investors missed out on buying back into companies they were invested in as markets quickly recovered.

This year’s market darling, Afterpay Ltd (ASX: APT) is a classic example of the scenario we are referring to, and it also provides some good comparisons in terms of the taxation impact on capital gains which we will go into later.

It’s all in the timing

Investors in Afterpay first got the COVID jitters in February as its shares plunged 10% from about $40.00 to $32.00 between mid-February and the start of March.

However, what was to follow was far worse - in the ensuing month the company went on to trade as low as $8.00.

But as the chart above shows, it was back above the $40.00 per share mark in no time, and took less than six months to hit $100.00 per share.

Examining a few entry and exit points makes for interesting reading.

Let’s use 2 March, 2020 as a common exit point (approximately $32.00 per share) as that is around the time that investors were getting nervous, not just about Afterpay, but about the speed at which the coronavirus was taking hold and the impact it was having on global markets.

Investors who purchased shares in APT on March 1, 2019 would have paid approximately $20.00 per share.

If we look at an investment of $20,000 (1000 shares), the investor would have made a gross gain of $12,000 based on the 2 March selling price.

This doesn’t include brokerage fees.

Because ‘Investor A’ held the stock for more than 12 months, only 50% of the realised gain of $12,000 would be subject to capital gains tax (CGT).

The financial impact of the taxable amount of $6000 would depend on the taxation category that applied to the investor.

As such, investors need to gain professional advice as to the impact of taxation liabilities based on their individual financial circumstances.

Selling inside the 12 month period

Investors who latched onto the APT story a little later in the piece, but before the COVID crash were looking at a higher entry price.

For example, the company’s shares were trading close to $30.00 on 2 January, 2020 which would represent an entry price of $30,000 for 1000 shares.

By offloading those shares on 2 March, ‘Investor B’ would have realised a gross gain of $2000, all of which would have been subject to CGT because they were held for less than 12 months.

As we mentioned, $6000 of Investor A’s gains weren’t subject to CGT, leaving him/her with only $6000 of the gain attracting CGT.

By comparison, all of Investor B’s gain of $2000 would have been subject to CGT.

Consequently, while Investor A’s gross gain of $12,000 far exceeded Investor B’s gain, in relative terms there would not have been a great deal of difference between the tax liabilities based on an even playing field with similar personal financial circumstances such as other tax commitments outside their sharemarket investments prevailing.

On a similar note, also remember that capital losses in the same fiscal year can be offset against capital gains.

This accounts for what is referred to as tax-loss selling, and you will often see companies that have performed poorly in the fiscal year sold down even more sharply in the weeks leading into 30 June as investors who have accumulated capital gains look to offload companies that appear to have little chance of a recovery.

It is worth noting that based on APT’s current trading range, if both Investor A and Investor B had not sold, they would be sitting on handsome ‘’paper gains’’ of $75,000 and $65,000 respectively with zero tax liability applicable to those investments.

Once again, this does not represent financial advice and because personal financial situations vary you should gain professional advice regarding CGT and other tax implications.