We develop a dynamic portfolio model incorporating capital gains tax (CGT), transaction costs, and year-end taxation. We find that even tiny transaction costs can lead to significant deferral of large losses and that transaction costs affect loss deferrals much more than gain deferrals. Our model can thus help explain the puzzle that even when investors face equal long-term/short-term CGT rates, they may still defer realizing large capital losses for an extended period of time, displaying the disposition effect. In addition, we find that misestimating transaction costs is costly. We also provide several unique, empirically testable predictions and shed light on recently proposed tax policy changes. This paper was accepted by Agostino Capponi, finance. Funding: M. Dai was supported by the National Natural Science Foundation of China Grants 72432005 and 12071333, the Research Grants Council of Hong Kong Grants 15217123, 15212324, 15213422, and T32-615/24), and The Hong Kong Polytechnic University [Grants P0039114, P0042456, and P0042708. Y. Lei was supported by the National Natural Science Foundation of China Grant 72271112. C. Yang acknowledges support from the Research Grants Council, University Grants Committee, Hong Kong Grants ECS 24207621 and GRF 14207723. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2023.03118 .
Min et al. (2026) studied this question.