Capital Gains Holding Periods and Equity Trading : Evidence from the 1998 Tax Act

1998 legislation reduced the minimum holding period for individuals to receive the most favorable long-term capital gains tax rate from 18 months to 12 months. This paper empirically documents the extent to which the reduction affected firm-specific trading volume and share prices. To our knowledge, it is the first study linking equity trading to a change in capital gains holding periods. Evidence presented in this paper indicates that trading volume soared and share prices fell for firms whose initial public shareholders immediately benefited from the 1998 reduction. The findings are consistent with the following interpretation: At least some shareholders wanted to sell their appreciated stock but were deferring their sales until the applicable capital gains tax rate dropped from 28 percent to 20 percent. When favorable capital gains tax treatment was suddenly possible through repeal of the 18-month holding period, individuals sold shares that qualified for the lower rate under the immediately applicable 12-month holding period. On the disclosure date (June 24, 1998), sales were sufficient in companies that had recently completed the 12-month holding period that share prices tumbled. Prices rebounded the following day, indicative of temporary price pressure