Tax
Nov 04, 2024|ByLincoln Fleming, CPA/PFS, CFP, MAcc
The bottom line
- Accumulating capital losses via systematic tax-loss harvesting in anticipation of future gains can serve as an insurance policy against future gain recognition events, providing enhanced flexibility to achieve future goals with minimal tax consequences.
- Long-only direct indexing portfolio may offer great loss harvesting opportunities. Tax-managed public equity long/short portfolio may further enhance loss-harvesting opportunities while adhering to an investor’s pretax investment thesis.
- Tax-loss harvesting may not be suitable for all investors and advisors should help clients determine its potential benefits and downsides based on their unique situations.
For many investors, systematic tax-loss harvesting may significantly reduce an investor’s tax burden and improve after-tax returns, especially when paired with active strategies that generate capital gains.
However, gain recognition events can take many forms, and countless investors without regular capital gains may still need to realize gains periodically. For example, gains may be realized when maintaining asset allocation targets, repositioning a portfolio, or during significant liquidity events like the sale of a business or rental property.
Forecasting future capital gains can be challenging, but accumulating capital losses in anticipation of future gains can serve as an insurance policy against future gain recognition events, providing enhanced flexibility to achieve future goals with minimal tax consequences.
Although the benefits of tax-loss harvesting are deferred until there are gains to offset, collecting losses over multiple years may allow an investor to offset more gains than if the program starts in the year of the taxation event.
Due to the risk characteristics of underlying investments, a long-only direct indexing portfolio may offer greater loss harvesting opportunities than bonds, equity mutual funds, or equity ETFs. Relaxing long-only constraints and introducing margin and shorting to create a tax-managed public equity long/short portfolio may further enhance loss-harvesting opportunities while adhering to an investor’s pretax investment thesis.
In their article, Lincoln and Taotao explore the significant tax benefits of strategies like loss-harvesting in anticipation of future gains and employing a tax-managed long/short public equity portfolio, while also examining potential tradeoffs and situations when such strategies should be avoided.
For advisors seeking to learn more, Lincoln and Taotao’s article is a must-read. Please find the full reprint by clicking here.
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Lincoln Flemming
CPA/PFS, CFP, MAcc
Taotao Cai
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This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, any historical performance information of other investment vehicles or composite accounts managed by BlackRock, Inc. and/or its subsidiaries (together, “BlackRock”) included in this material is presented by way of example only. No representation is made that any performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example. Past performance is no guarantee of future results.
Due to the complexity of tax law, not every single taxpayer will face the situations described herein exactly as calculated or stated; i.e., the examples and calculations are intended to be representative of some but not all taxpayers. Since each investor’s situation may be different in terms of income tax, estate tax, and asset allocation, there may be situations in which the recommendations would not apply. Please discuss any individual situation with tax and investment advisors first before proceeding. Taxpayers paying lower tax rates than those assumed or without taxable income would earn smaller tax benefits from tax-advantaged indexing or even none at all compared to those described.
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