Market Valuation of Tax-Timing Options: Evidence from Capital Gains Distributions

Abstract

We examine a distribution that is taxed as a capital gain rather than as a dividend. Since the distribution induces a realized capital gain while the price change is an unrealized gain, ex-day return behavior provides evidence of the value of tax-timing capital gains. We show that investors are compensated 7¢ in unrealized gains for each dollar of realized capital gains, that is, $1 of realized capital gains is equivalent to 93¢ of unrealized gains. An investor with a tax rate on realized gains of 15% has an effective tax rate on unrealized capital gains of 8.6%.