There’s Still Time to Reduce Tax Drag

• There are two common ways to potentially lower a portfolio’s tax burden: avoiding capital gains distributions and tax-loss harvesting. 
• More than a third of funds that have reported capital gains are expected to pay out this year.
• Tax loss harvesting opportunities abound in the Core bond as well as intermediate and long-term municipal bond fund categories

As we head into the final stretch of 2024, tax planning and strategies come to the forefront as the 12/31 deadline approaches. And tax costs cannot be ignored. For example, over the past 10 years, the average actively managed large cap mutual fund had a tax cost of 2.09%, more than twice the average expense ratio at 0.86%.¹ There are two common ways to potentially lower this tax burden: avoiding capital gains distributions and tax-loss harvesting. 

Most fund companies distribute capital gains during year-end, so now is the time to be alert. So, what does this year look like? With more than half of all funds reporting capital gains estimates thus far, here is what the current landscape looks like:

Additionally, tax loss harvesting may allow investors to offset tax costs from gains and up to $3,000 in income by selling investments at a loss.⁵ Some investors may use sales proceeds to purchase a comparable investment, and in doing so, can maintain a similar asset allocation.

To ensure that investors don’t get a tax break and then instantly buy back their original investment, the government has what’s known as the “wash sale” rule. The rule mandates that an investor cannot claim a loss on the sale of an investment and then buy a “substantially identical” security for the period beginning 30 days before and ending 30 days after the sale. Because the IRS has not clearly defined what constitutes “substantially identical” securities, investors have interpreted the rule differently. When choosing to reinvest proceeds in a similar investment, many tax practitioners suggest that investors ought to consider the degree to which its holdings may overlap with the original investment, and the degree of difference in their prospective returns. Of note:

To help parse through this data, the BlackRock Tax Evaluator tool compiles capital gains estimates across more than 7,000 funds and helps identify potential tax-loss harvesting opportunities. By aggregating this information in one place, the tool could save advisors hours while differentiating their practice through a focus on after-tax returns.

Use the tool to help maximize after-tax returns, and help clients keep more of what they earn.

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