As the year winds down, we would like to remind clients and friends of a rewarding opportunity to unlock tax savings, boost returns and strengthen their municipal bond portfolio.
Through a tax swap – a form of tax-loss harvesting – investors can minimize the tax impact of selling profitable assets while securing high-quality, long-term municipal bonds.
It’s a relatively simple strategy, and with volatility in both the stock and bond markets this year, there are ample opportunities for investors to take advantage of it.
Tax-loss harvesting
Typically, we advocate investors buy and hold their municipal bonds until they mature or are called. As the securities are held, their market prices will fluctuate. Sometimes bonds will be worth more than the investor paid for them, other times less.
These swings are unimportant. Municipal bonds pay tax-free interest and have a stated maturity date with the promise to return principal. Our goal with munis isn’t to generate a capital gain, it’s to maintain an uninterrupted stream of tax-free income.
However, there are times when it’s prudent to take advantage of big changes in stock and bond prices.
Consider an investor who would like to cash in on gains she earned in propitious stock investments. At the same time, she owns municipal bonds whose market price has dipped.
By cashing in both, the sale of the bonds will cushion the tax blow of the stock sale, and at the same time she can use the proceeds of the sale to acquire other municipal bonds (and take advantage of today’s highly attractive yields, “Rate Cuts Shines on Muni Bonds”).
This move allows the investor to take the loss for tax purposes and offset capital gains, dollar for dollar – short or long term – without losing her position in the municipal market or missing a day of interest.
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This is unique: No other market affords investors the ability to do this at the same time without running afoul of the IRS “wash/sale rule.” It should be noted that to avoid the wash/sale rule, investors must purchase a “substantially different” bond than was sold, without losing one day’s interest.
Other options
Investors can use this tool even if they have no gains. The IRS allows investors to offset up to $3,000 per year of adjusted gross income and carry forward any remaining losses, dollar for dollar, into subsequent years.
Tax swaps have always been a popular strategy and we expect a surge of activity as the year ends. We can help investors navigate this approach, but executing these trades becomes more challenging the closer we are to Dec. 31, so it’s best to start planning now.
Of course, consult your tax professional to discuss how this strategy applies in your specific situation.
We can help you from there.