Considerations for Tax-Loss Harvesting Season

On Tuesday, we looked at tax-loss harvesting – the act of selling a losing security to offset some of the capital gains taxes incurred when parting with a winning position.

With just over two months left in 2021, meaning tax season is right around the corner, the tax-loss harvesting conversation is one advisors should be initiating with clients over the near-term. After all, plenty of advisors know their clients aren't tax experts and none of them want to pay more taxes than they're legally required to do.

In simple terms, tax-loss harvesting is a considerable value add for clients because they likely fall into one of three groups 1) aren't aware of it in the first place 2) know about it and don't know how to implement it or 3) are wanting to hold onto a losing position and don't realize there are benefits to parting ways with that laggard.

Translation: Tax-loss harvesting, for as wonky as it sounds, is viable avenue for contacting and connecting with clients at this time of year. However, there's more to the story and the “more” favors both advisors and clients.

It's All About Implementation

Tax-loss harvesting is indeed a strategy, meaning implementation is of the utmost importance. Clients won't derive much benefit from blindly selling a stock or a fund simply because it's in the red this year. After all, it could be a legitimate rebound candidate and if the client moves into something else that's comparable to the sold position, he or she could run afoul of IRS wash sale rules.

Fortunately, 2021 is presenting advisors with some fairly easy tax-loss harvesting opportunities thanks to weakness in the bond market. Of course, that's a broad statement. Not all bond segments and funds are struggling and data confirm market participants remain fond of fixed income exchange traded funds.

Still, it cannot be ignored that the Bloomberg US Aggregate Bond Index is off 2% year-to-date and that the Federal Reserve is likely to raise interest rates at least once next year. Said another way, bonds are fertile territory for 2021 tax-loss harvesting.

“Because the income received is such a large component of a bond’s return, this asset class often can be overlooked when tax-loss harvesting. Investors often view a bond exposure as having generated positive total return due to the income received, when the price return has a loss,” according to State Street research.

This nugget, courtesy of State Street, illustrates why bond ETFs are excellent ideas for 2021 tax-loss harvesting: Four out of five of those funds are saddled with year-to-date losses due in large part to the surge in 10-year Treasury that started late last year, lasting through much of the second quarter. A third of those ETFs have a loss of 2% or more. Here are some direct ideas for bond ETF tax-loss harvesting.

“Our research shows five key areas where investors may potentially harvest losses: Intermediate Core, Corporate Bonds, Intermediate Government, Long Government, and Intermediate Core-Plus. 87 funds across these five segments — with total net assets of more than $470 billion — have experienced price losses greater than 2%,” adds State Street.

Putting It Into Action

As I noted in my piece earlier this week, the IRS doesn't consider ETFs and mutual funds to be identical securities, so if clients are saddled some turkeys among fixed income mutual funds, consider a move to ETFs because not only will a tax benefit be gained, but likely so will the added perk of lower expense ratios.

Among mutual funds in the Intermediate Core, Corporate Bonds, Intermediate Government, Long Government, and Intermediate Core-Plus categories “more than 50% of the funds are currently at a loss. Notably, some of these funds are actively managed and may be outperforming their benchmark even if at a loss,” according to State Street.

As for where to go, bank loans and convertibles are among the bond segments positively correlated to rising rates while intermediate-term bonds are less correlated to equities than long duration equivalents, providing portfolios with more diversification.

Related: Another Tax Strategy for Advisors to Discuss with Clients