What is 'Crystallization'

Crystallization is the selling of a security to trigger capital gains or losses. Once a capital gain or loss has been realized, investment tax applies to the proceeds.

Next Up

BREAKING DOWN 'Crystallization'

When an investor buys a capital asset, an increase (or decrease) in the value of the security does not translate to a profit (or loss). The investor can only make claim to a profit (or loss) after he has sold the security. Selling the security at a profit is referred to as crystallizing a capital gain.

Consider an investor, Smith, who purchases 100 shares of Nvidia Corporation (Nasdaq: NVDA) on October 13, 2016 for \$65.35. The stock has steadily increased since he bought it and as of September 18, 2017, was \$187.55. Until Smith sells the stock, he cannot crystallize the gain from the increase or state that he made a profit. If he decides to sell the stock for \$187.55, his capital gain will be (\$187.55 - \$65.35) x 100 shares = \$12,220. In this instance, he has crystallized \$12,220 capital gains.

Smith may not get to relish in his good fortune for long since capital gains are taxed. As of 2017, the capital gains tax on a short-term investment is equal to an investor’s ordinary income tax rate. Long-term capital gains tax rate, depending on what marginal tax bracket an investor falls into, lies between 0% and 20%. Assuming Smith’s annual income for 2017 is \$120,000, this means he falls in the 28% marginal income tax bracket, and therefore, the capital gains tax on his NVDA profit will be 15%. At the end of the tax year, he will pay 15% x \$12,220 = \$1,833.

Capital losses may be used to offset some or all capital gains. If Smith held 700 shares of Transocean Ltd. (NYSE: RIG) which he bought for \$15.80 per share a year ago, but now trading in the capital markets for \$7.30 per share, he can crystallize the capital loss on the investment to offset the capital gains on NVDA in order to reduce the capital gains tax bill. If he sells RIG, he will crystallize losses of (\$15.80 - \$7.30) x 700 = \$5,950. Instead of reporting a capital gain of \$12,220, Smith can instead report a gain of \$12,220 - \$5,950 = \$6,270. Since he has used his crystallized capital loss to offset his gain, his capital gains tax will be 15% x \$6,270 = \$940.50.

Crystallization can be used as a strategy in selling and buying stocks almost instantaneously in order to increase or decrease book value. An example of this occurs when an investor needs to take a capital loss for a particular stock, but still believes the stock will rise. Thus, s/he would crystallize the paper loss by selling the stock and buying it back right away. In our example above, Smith sold his RIG shares for a capital loss in an effort to reduce his capital gains tax liability. If Smith believes that the stock still has the potential to increase in value, he can re-purchase it for his portfolio.

Crystallizing a tax loss is not a problem. What you do after crystallization, though, might be a problem. Most tax agencies have regulations (such as the wash-sale rule) to prevent taking a capital loss in some dubious fashion. In the US and Canada, for example, an investor cannot claim a tax loss if he buys back the shares within 30 days of crystallizing a loss from the same shares. Following the example above, Smith will have to buy back Transocean shares after 30 days has passed.

Capital losses that have been crystallized can be carried forward indefinitely. The capital loss can be used to offset realized gains and reduce ordinary income tax (up to \$3,000 per year) in subsequent years. For example, an investor who crystallizes \$20,000 capital loss can apply this to his crystallized \$5,000 capital gain. Since she will still have \$15,000 after reducing her capital gains tax to zero, she can use up to \$3,000 to reduce her ordinary income tax as well. For example, if her annual income for the year is \$85,000, she will only be taxed on \$85,000 - \$3,000 = \$82,000. The remaining \$12,000 in crystallized losses can be used in the following years in the same manner.

RELATED TERMS
1. Tax Swap

Tax swap is a method of crystallizing capital losses by selling ...
2. Floating Charge

A floating charge is a security (i.e. mortgage, lien, etc.) that ...
3. Long-Term Capital Gain or Loss

A gain or loss from a qualifying investment owned for longer ...
4. Capital Gains Treatment

The amount of time a stock is owned before being sold determines ...
5. Tax Rate

A tax rate is the percentage at which an individual or corporation ...
6. Recognized Loss

Recognized loss is when investments are sold for less than their ...
Related Articles
1. Taxes

How to deduct stock losses from your tax bill

Learn the proper procedure for deducting investment losses and get some tips on how to strategically structure them to lower your income tax bill.
2. Taxes

Comparing Long-Term vs. Short-Term Capital Gains Tax Rates

Learn about the difference between short- and long-term capital gains and how the duration of your investment can impact your tax liability.
3. Taxes

What You Need To Know About Capital Gains And Taxes

Find out how your profits are taxed and what to consider when making investment decisions.
4. Tech

Using Tax-Loss Harvesting to Keep Your Gains

Harvesting tax losses is a key skill that investors can use to keep more of their money in their pockets the next time they file taxes.
5. Insights

Adam Smith: The Father of Economics

Adam Smith is renowned as "The Father of Economics" for his work in pioneering ideas such as free trade and GDP.
6. Investing

A Complete Guide to Tax Loss Harvesting With ETFs

Using exchange-traded funds (ETFs) to harvest tax losses can be a smart way to maximize your portfolio's tax efficiency.
7. Investing

7 Tips for Tax-Managed Investing

Use these seven tips to reduce the tax impact on your taxable portfolio.
8. Taxes

Capital Gains Tax Cuts For Middle Income Investors

Find out how TIPRA plans to slash taxes for those in the 10-15% tax bracket.
9. Investing

Could Chinese Stocks be the Next Big Short?

Crescat Capital has pointed to signs that the Chinese stock market may reach a crisis point.
10. Taxes

5 Tax-Efficient Portfolio Tips for High Income Earners

High income earners can use these tips to make their portfolio more tax-efficient.
RELATED FAQS
1. Is there a difference between capital gains and dividend income?

Selling something for a profit leads to capital gains. A payment made by a corporations to stockholders is a dividend. Both ... Read Answer >>
Hot Definitions
1. Discount Rate

Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
2. Economies of Scale

Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
3. Quick Ratio

The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
4. Leverage

Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
5. Financial Risk

Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
6. Enterprise Value (EV)

Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...