Long-term or Short-term?

This post is a quick stroll down algebra lane to figure out whether holding on to something for the (more favorable) long-term capital gains rate really makes sense or not. I’ve discussed this sort of problem with a couple people and I’m recording my ideas for reference, posterity and criticism…

This evening I was thinking about the cliff in taxation between short-term capital gains and long-term capital gains. Something is “long-term” if held for a year or more, or if you’re forced to sell it because you’re hired into a position in the Bush administration. (No, I’m not making that part up.)

Short-term gains are taxed at the normal income rate which is 25 or 28% for most software developer/system administrator folks I know, and long-term is taxed at 15% in most cases. (These numbers may change at Congressional whim. And while I’m disclaiming things here: I am not your tax or investment consultant, you should consult one if you want advice you can hold someone liable for. Beware of dog. Slippery when wet.) I’m going to pretend the AMT doesn’t exist for purposes of this exercise. (If your capital came from stock options, the IRS sadly will not let you pretend the AMT away.)

This leads to a problem of deciding if the risk of waiting longer is worth the 10-13% difference in tax rate. The rate only applies to the gain, not the full amount. The amount the captial is worth in-pocket is the price minus whatever capital gains tax applies.
So a useful application of algebra:

Net = Price – (Price – Paid) × Taxrate

The net right now is probably going to be at the higher short-term rate. The market goes up and down a lot, and it’s no good if by the time the long-term rate applies the net is going to be less than it is now. You can’t necessarily time the market and know where it’s going, but some industries have pretty obvious seasonal trends. What price can the capital drop to before it’s a better deal to sell now? We know the net we can get right now because of the equation above. So now we need to find the price for another tax rate, so solve for Price:

Net = Price – (Price – Paid) × 15%

Net = Price – (15% × Price – 15% × Paid)

Net = Price – 15% × Price + 15% × Paid

Net – 15% × Paid = Price – 15% × Price

Net – 15% × Paid = (1 – 15%) × Price

(Net – 15% × Paid) ÷ (1 – 15%) = Price

So if I paid 6.50 for something that’s now worth 20.00 short-term, that’s equivalent to 18.41 long-term. That is if it is likely to drop in value more than about 2.50 by the time the one year “long-term” timer runs out,

In just 6 months time, you’ll need to net 2% more just to keep up with the current rate of inflation.

((102% × Net) – 15% × Paid) ÷ 85% = Price

So now I’m at 18.80 long-term vs. 20 now. If I think there’s an even money chance that it’ll lose 1.20 in 6 months, I’d be better off to sell now and invest in something that has a more favorable trajectory.

“Timing the market” is a foolish adventure, but blindly waiting for the long-term is an unnecessary risk if the value moves in a seasonally predictable way that’s not in your favor.

I’ve setup a Google Spreadsheet with this math in it for the curious.

Ribbit

In the front yard.

Coast Starlate

NPR had a story this morning about the Coast Starlate train that runs between Seattle and Los Angeles. It’s good to see press coverage of the problems this line is having. (e.g. From October 2005 through August 2006 the train delivered its passengers on-time only 2% of the time.) Maybe with enough coverage Union Pacific can be shamed into helping the trains run on time.

Not My Dream App

There’s a new contest at MyDreamApp.com for new Mac OS X software. The format for the contest with celebrity judges and open submissions from the user community and prizes for the top 3 entrants sounds like a lot of fun. A lot of fun, that is until you read the fine print.

Participants are forbidden from making their dream app open source if it’s selected as a winner. That’s right, by participating in the contest you agree to give up all interest in your idea and any code you put behind it to the group organizing the contest. If you wanted to give back to the community by offering your awesome idea for free or, better yet, offering it as open source software, you’re out of luck.

But wait, there’s more; the deal gets even better. In return for giving away your idea they’ll offer you a meager 15% royalty from ”net income” from the Mac version of the idea. “Net” in this context means if they spend money advertising, promoting or paying developers/QA/writers to work on the Mac version of the product that gets subtracted from the amount you get 15% of. This is exactly how many musicians get screwed out of the proceeds from their music by record companies. “You know it cost a lot to promote your album, so here’s a free cup of coffee. We look forward to your next effort.”

Just to top it all off, some top finishers get free equipment. The catch? The taxes on the giveaway are your responsibility. So you have to pay out of pocket federal, state and local taxes (let’s say 28%) of the value of the “free” item. I’m going to guess that the 15% of “net income” may not be enough to cover the taxes on the free item.

Did I mention the liability release provision potentially allows the organizers to skip out and not pay you anything? And if they do pay you it will be through PayPal. And if your submission is accepted you may not even be able to claim it was your idea on your resume without their permission. And, worst of all, if the effort required for them to follow through on making your idea a shiny product is more than “reasonable” they can just walk away and develop it for Windows instead. (And pay you nothing.)

It’s an interesting way for some people to feed on the creativity of others, and I guess if people understand all this and still participate, that’s their business. I’m a little dismayed that Woz and other luminaries are participating in something that seems so potentially abusive of it’s “winners”.

This isn’t to suggest that the people organizing the contest will do any of these nasty unkind things, only that they could if they wanted to. I don’t know any of them, and I hope, for the sake of those who participate, they stay honorable.

It would be nice if someone had an open source-friendly contest (with nicer rules) along these lines for great new open source Cocoa titles in the tradition of Adium and Colloquy.