The one-year line is worth 17 cents per dollar

Two investors buy the same stock on the same day and each makes a $10,000 gain. One sells on day 364, the other on day 366. In California’s top bracket the first pays $5,210 of tax and the second pays $3,510. Nobody reading this page needs that rule explained. The IRS’s own count says it gets crossed early anyway.

In 2015, the last year the IRS published sales by holding period, individual filers realized $3.3 billion of stock gains on shares held nine, ten or eleven months: 5.1 million sales, each within three months of the lower rate. Across the six months after the line, realizations average about $1.8 billion a month, so plenty of people do wait for it. Enough do not that short-term gains were 15% of all the stock gains individuals reported that year, and the under-a-month trading column accounts for less than a third of them.

How a rule everyone knows still gets crossed

Almost nobody sells at month eleven in order to pay more tax. The sale has another reason, and the calendar is not part of it.

• A rebalance that sells the newest lot. Selling the highest-cost shares first is the tax-aware way to pick a lot, and the highest-cost lot is usually the most recent one. The rule that minimizes the gain can maximize its rate.
• Shares that vested this year. Employer stock sold to diversify within a year of the vest is a short-term gain on whatever it rose since. Diversifying is the right call; the date is a free variable.
• A harvest replacement swapped back early. The fund bought after a loss harvest is a new lot with a new clock. Trading back into the original once the 30-day wash-sale window closes, but before a year, realizes any gain at the higher rate.
• Cash raised in December. A tax bill or a tuition payment, funded from whatever is up, and whatever is up is often what was bought last.

Brokerage records show the same thing from the other side. Ivković, Poterba and Weisbenner compared the same investors’ trades in their taxable and retirement accounts and found that inside the first year the urge to take a profit outweighs the tax reason to wait; the reluctance to sell a winner in a taxable account only shows up once the shares have been held twelve months.

What each crossing costs, and why it is certain

Federal, 37% against 20%: 17 cents on every dollar of gain at the top bracket. The 3.8% investment tax and California’s rate apply on both sides of the line, so the whole gap is federal, and a top-bracket Californian and a top-bracket Texan lose the same 17 cents by crossing early. In the 24% bracket with no state tax the gap is 9 cents. There is no bracket where it is zero.

Nothing about the market enters that arithmetic. A tilt or a diversifier is a bet on the next twenty years; the 17 cents is in the statute before the year starts, and it is paid or kept on the day of the sale.

Dividends have their own version of the line. A dividend is qualified, and taxed at the 20% rate, only if the stock was held at least 61 days in the 121-day window around the ex-dividend date, without a hedge on it. Otherwise it is ordinary income at 37%.

The rules that stop shortcuts

Four rules exist so that nobody manufactures long-term treatment, or dodges it, with clever positions.

• Straddles. Hold a stock and an offsetting position at the same time and the holding period stops running. Losses on one leg are deferred while the other leg is open.
• Constructive sales. Put a tight collar on an appreciated stock, or short it against the box, and the tax code treats the position as sold that day. The gain is due.
• Hedged dividends. Any hedge that “diminishes the risk of loss” while you hold the stock disqualifies the dividend from the 20% rate.
• Index options. Options on a broad index such as the S&P 500 are marked to market at year-end and taxed 60% long-term and 40% short-term no matter how long they were held, a blended 26.8% federal rate. Options on a single stock, or on an ETF, do not get this treatment.

What it means in practice

Give every taxable lot a date before you give it a reason. A rebalance, a diversification sale or a cash need can usually take the lot that has crossed, or wait the weeks it takes to. The one crossing that pays for itself is a stock you expect to fall by more than 17 cents on the dollar before its anniversary, and that is a forecast. The 17 cents is not.