Wall Street banks have found a silver lining in this year’s market slump: make money by helping wealthy clients sell some investments at a loss to ease their tax burden.
This so-called “tax-loss-harvesting” strategy has been around almost as long as the Federal Tax Code – which was in effect in the second decade of the 20th century.
JPMorgan Chase last week launched a new “tax-smart” platform focused on collecting tax losses, joining financial groups like Morgan Stanley and BlackRock to offer automated products to help investors profit from the strategy.
“That’s the only gift you have in a weak market. A loss has economic value,” said a money adviser at a major US bank, noting that most of the calls from clients in recent weeks have been about tax losses.
Tax loss management is aimed at investors who have steadily increased their holdings over a period of years. Recently purchased stocks that have fallen in value are sold at a loss that can be deducted from any capital gains realized in that year or in the future. The S&P 500 stock index fell 21 percent in 2022.
“A priority this year is to make sure that at least people don’t pay taxes on their portfolios,” said a private banker at a Wall Street firm.
Typically, investors will sell and then buy back a portfolio with a similar risk profile. Under the IRS’s “wash sale” rule, investors are prohibited from selling a security at a loss and then repurchasing the same investment for 30 days.
“After 10 years of bull market, this is an opportunity for clients to take advantage of tax losses,” said another private banker.
Tax loss harvesting is one of several strategies US banks and money managers use to minimize taxes for well-heeled investors. Some of these clients also hold profitable positions and use them as collateral for loans from major banks, thereby generating money for expenses without reporting taxable income.
“Our tax code and the way it treats the rich is a common overall problem,” said Steve Wamhoff, director of federal tax policy at the Institute on Taxation and Economic Policy, a Washington-based think tank. “They have this incentive to take losses as quickly as possible. But then they have this incentive to avoid profits.”
The strategy has become more mainstream in recent years with the rise of direct indexing providers such as Morgan Stanley-owned Parametric and BlackRock’s Aperio. These allow investors to own a group of stocks that mimic the performance of an index and adjust the portfolio to account for tax losses.
US investors pay tax at their marginal income tax rate on gains on assets held for up to one year, with lower capital gains tax rates for assets held longer.
In a note to clients in May, wealth manager State Street Global Advisors wrote that this could be “the biggest tax-loss recovery opportunity in decades.”
By the end of August, State Street estimated 99 percent of mutual funds and exchange-traded funds were trading at a loss for the year. Rising interest rates from central banks around the world have also hit bond investments.
“It’s created a really, really bounty crop of losses for investors this year,” said Matthew Bartolini, managing director at State Street Global Advisors.
In fiscal 2020, there were $19.3 billion in net capital losses that could be used to offset capital gains, up 19 percent from $16.2 billion in 2019, according to the latest available data of the Internal Revenue Service.
Collecting tax losses isn’t just for US clients – in the UK tax year 2020-21 more than £2bn of investment losses were offset against capital gains to reduce personal tax burdens.
David Henry, investment manager at UK wealth manager Quilter Cheviot, said collecting tax losses could be “very, very strong” and is currently popular with property owners in the UK who are sitting on big profits but are selling in anticipation of rising mortgage rates, dragging house prices down.
You’ll also make greater savings as capital gains tax in the UK is charged at a higher rate on taxable assets than on all other assets, namely 28 per cent and 20 per cent respectively for higher and additional taxpayers.
Henry added that the past few days have presented opportunities in the UK government bond market. Investors who maintain losses in exchange-traded funds can sell them, crystallize the loss and buy back bonds outright; Any difference between a bond’s price and its maturity value can be held tax-free.