Does Apple Have a Parachute for the Fiscal Cliff?
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As the stock market continues to digest the results of Tuesday’s Obama re-elect, the impact of the fiscal cliff is playing a central role in driving prices. One of the critical concerns facing investors is the potential hike in the capital gains tax that could see profits hurt as early as January. To this end, CNBC’s Jim Cramer recommended selling Apple (NASDAQ: AAPL) ahead of year-end to protect the sizable profits that many are holding as unrealized profits. Apple’s stock, which is down over 20% from its all-time high above $700, has continued to slide since the election. While Mr. Cramer makes a valid point, the continued sell-off has become a buying opportunity.
Looking at the chart below, you can see that despite the recent correction, Apple is still up nearly 35% in the last year. This means that many shareholders have significant profits that qualify as capital gains. Remember that to qualify as long-term capital gains you must have held the stock for longer than a year; otherwise profits are treated as ordinary income. Apple has been a strong performer for investors, but when considering the tax consequences of your holdings, it is important to take potential changes in the tax code into account.
Cramer believes that this concern has driven the continued sell-off since the election: “These people are natural sellers and they don't care that next year could be better, they want to take the gain this year to get the tax break, which is worth more than any capital appreciation they could hope for." Whether you are a loyal Apple fan or considering initiating a new position in the stock, it is important to consider the backdrop against which the stock is trading.
The Wash Sale Rule
While it would have been of significant benefit to current shareholders to sell Apple when I initially recommended getting out, there are still steps that can be taken to protect yourself. Under the tax code, there is a provision known as the wash sale rule that prevents an investor from selling a security at a loss in order to lock in that loss for tax purposes and then buying the stock back within thirty days. The principle is that investors should not be able to avoid taxes by selling and then immediately buying back the same, or substantially the same, securities.
The wash sale rule does not, however, apply to gains. What this means is that if you have been an Apple shareholder for over a year, you can sell your shares to lock in your profit at the current capital gains rate and then buy those shares back immediately. This guarantees that your profit will be considered under the current capital gains rate.
If we consider this reality against Mr. Cramer’s explanation of Apple’s sell-off, there are only two possible conclusions we can draw. The first is that investors either do not understand the wash sale rule – which is perfectly possible – or that they are using the fiscal cliff and capital gains concerns to sell the stock as they wanted to in any event. The second possibility is that the explanation is wrong. As long as the sale is completed before the end of the year, the current tax rate would apply. There is certainly an argument that tax-driven selling may put pressure on the stock, making it prudent to sell early, but the immediate reaction to the election results – while still in the midst of a sustained correction – suggests that there is more at play.
Mr. Cramer’s analysis that taking gains in higher dividend stocks like AT&T (NYSE: T) and Consolidated Edison (NYSE: ED) makes more sense under his line of reason. Taking profits in stocks that garner significant appeal from dividends that may be taxed at a much higher rate is reasonable. There is definitely some tax maneuvering in play, but I do not believe it is the primary driver of Apple’s performance.
A Buying Opportunity
As the country comes out of the fog that invariably settles over our psyches heading into a presidential election, the real problems that still exist are being remembered. Unemployment persists, Europe is still a mess and the fiscal cliff has not evaporated. It is against these concerns that the market is purging its metaphorical stomach with a multi-day wretch. Apple shares, however, had already largely taken care of their needed correction, making the additional sell-off an opportunity to buy shares even lower. I believe the holiday season will prove successful for Apple and recommend buying shares here.
Know What You Own
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Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple and AT&T.; Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.