There are many instances in which the
government demands a minimum holding period for an investment to
obtain a long-term capital gains tax rate in order, I assume, to
prove that the investment wasn't a speculation or merely a tax
Most investors are aware that in order for
an individual taxpayer to get favorable tax treatment on a
qualifying dividend, the dividend recipient must have held the
shares for a minimum of 61 days.
The minimum-holding-period rules on
dividends go way back. Corporations have always received a tax
break on dividends that they get from another corporation in
recognition of possible cascading levels of tax on the same
Originally, such corporations had to hold
shares only over the record date to get the tax break. The
government threw sand in the gears, creating a 16-day minimum
In 1984, when companies were perceived to
be “dividend stripping,” the rules were changed again, lengthening
the minimum holding to 46 days. This is still the minimum time for
a corporate dividend recipient.
When the Bush administration granted a
dividend tax break to individuals, Congress implemented a 61-day
minimum, thinking that 46 days represented too brief a time for
all taxpayers. Ironically, if one shorts a stock and pays out a
dividend expense, that payment is allowed as an interest deduction
only if it is short at least 46 days.
That is right: 61 days for dividends
gotten and 46 days for dividends paid out.
Other situations demanding minimum holding
periods are exchange funds (seven years), specialized
small-business investment companies (five years), extraordinary
dividends (two years), incentive stock options (two years from
grant) and tax-free income from a fund (six months).
The rules for taxpayers who receive
long-term-gain distributions from mutual funds or real estate
investment trusts require a six-month holding period — while
curing a constructive sale requires 61 days, wash sales 31 days
and foreign-dividend tax credits 16 days. These holding period
rules are a work in progress.
In 1867, all gains were defined to be
included in the taxable-income base. An 1872 court case reversed
that by deciding that all gains are to be free of tax.
This lasted until 1913 when gains went
back into the tax base.
In 1921, long-term gains were first given
preferential tax treatment. The minimum holding period for this
tax break was two years.
In 1934, things got complicated with a
graduated system sliding scale of five different possibilities:
100% taxed as income if held for less than 12 months, 80% taxed if
held for one to two years, 60% taxed if held two to five years,
40% taxed if held five to 10 years, and just 30% taxed if held
more than 10 years.
This sliding scale lasted until 1938, when
the system was slimmed to just three possibilities: short-term,
long-term at 18 months, and super- long-term if held over two
years. In 1942, the holding period to achieve long-term status
went down to six months and stayed there until 1977.
In 1977, the minimum holding to get
long-term treatment was changed to nine months. In 1978, it was
changed to 12 months, where it sat until 1986, when long-term
gains lost their preferential treatment.
In 1991, the clock was set
back to pre-1986 status in which long-term gains got a tax break
if the asset was held for more than 12 months; 1997 added a super
long-term benefit at 18 months (this was yanked after a year), and
that brings us to where we stand today.
Clearly, we can do all the tax planning we
want, but we must not ignore the fact that the assumptions we make
are just that: assumptions. What if one continually defers gains,
only to find out that when sold there is no longer a capital gains
break (as from 1986 through 1991)?
I am not predicting anything specific
here, just observing that tax rates have been low for the past few
decades and the pendulum usually swings both ways.