As of September 30, 2022, the current year is the worst start for bonds since 1926 as the overall U.S. bond market is down nearly 15%. While this is disappointing, it also creates a unique, once in a generation, tax loss harvesting opportunity. This strategy can reduce current and future taxes.
Tax loss harvesting is a tactical portfolio strategy to sell holdings to capture the capital losses, which can then be used to offset current or future capital gains. Further, the losses can be used to offset ordinary income up to $3,000 if there is an overall capital loss for the year.
Once the holding is sold for a loss, the money can then be reinvested in a holding that has similar overall characteristics but is not “substantially identical.” A substantially identical holding would violate the wash sale rule which states that if you sell a holding for a loss and buy the same or substantially identical holding within 30 days before or after the sale, the loss is typically disallowed for current tax purposes.
While stocks, ETFs and mutual funds can be tax loss harvested in the current year, bonds present a compelling opportunity given their characteristics.
Consider the following example:
- The bond was purchased at $120 but has declined to $100
- The bond is sold, recognizing a $20 loss for tax purposes
- A new bond is purchased at $100, which is equal to the par value of $100 at maturity
- If you hold to maturity, you never pay capital gains on this bond but were able to recognize a capital loss on your former bond to offset current or future capital gains
- If the example above was executed on a $10 million bond portfolio, the result would be over $1.6 million of future capital gains tax-free which is up to a $600,000 cash tax benefit in high tax states
The example above also applies to bond funds or a combination of individual bonds and bond funds. At Essential Partners, we manage each unique situation to effectively mitigate taxes over the long-term using the custom tools at our disposal.
In “normal” times, Essential Partners utilizes a leading technology platform for monitoring and trading client partners’ accounts to actively tax loss harvest. For instance, the technology application results in automated, proactive monitoring and recommendations for tax loss harvesting opportunities. The recommendations are provided to Essential Partners daily, who then applies a human, analytical lens to ensure the action is warranted given each client partner’s unique situation. This technology is used in coordination with Essential Partner’s investment allocations to designate alternative holdings to purchase as tax loss harvesting is executed.