Tax-Loss Harvesting Is Once Again Center Stage in 2023
5 min read
Harvesting losses involves selling investments that have declined in value—whether it’s individual securities or commingled vehicles—in order to offset capital gains elsewhere in a taxable account. Additionally, if investment losses exceed gains at the end of a given year, it’s possible to offset up to $3,000 of noninvestment income, which is extra beneficial if the investor’s income tax rate is higher than the capital gains tax rate. If losses are more than $3,000, investors can carry the excess losses forward, using them to offset future capital gains and ordinary income over their lifetimes.
For much of 2023, municipal bonds provided investors with positive returns in the low single digits. But starting in late September, the market has given back much of its year-to-date gains. Through October 20, 2023, the Bloomberg Municipal Bond Index returned –2.20% this year, –5.56% of it a result of price changes. Although we believe that this creates an increasingly attractive entry point for investors, the losses observed so far this year (not to mention those harvested in prior years) also make it an opportune time for some investors to consider tax-loss harvesting.
How Tax-Loss Harvesting Has the Potential to Work with ETFs
For many investors, exchange-traded funds (ETFs) have become a valuable tool for reinvesting proceeds from sales that generate tax losses. These vehicles are liquid, can be bought and sold on centralized exchanges, and are tax-efficient. To see how this might work, let’s assume an investor’s portfolio includes a passive ETF that has returned –5% so far this year.
The investor could sell the passive ETF position, realize tax losses and reinvest the proceeds in a short-duration ETF (such as TAFI, AB Tax-Aware Short Duration Municipal ETF, or YEAR, AB Ultra Short Income ETF), maintaining bond exposure with less interest-rate risk.
A Simple Example: How Harvesting Losses Can Add Up
Over time, the benefits of effective tax-loss harvesting can be significant. We can see the impact with a simple example using two portfolios with an initial $100,000 investment, each generating a 5% return per year over 10 years. The tax-loss portfolio realizes $3,000 per year in tax-loss harvesting benefits, while the control portfolio doesn’t.
Based on an assumed capital gains tax rate of 20%, the tax-loss portfolio would end the 10-year period with a value of approximately $155,000, significantly higher than the roughly $149,000 for the control portfolio, which doesn’t use tax-loss harvesting (Display). That advantage translates into a cumulative total-return advantage of 4.5%.
Potential Wash-Sale and Other Benefits from ETF Structures
In addition to maintaining market exposure, tax-loss harvesting that involves buying an ETF may avoid violating the wash-sale rule, which prevents investors from claiming losses on the sale of an investment if they buy an identical one within 30 days. The ETF wrapper is also well suited to taxable accounts, because it offers benefits versus mutual funds:
- Because ETFs are exchange traded, ETF investors may be insulated from individual investors’ trading. So, if an investor decides to sell shares of an ETF, the transaction will usually happen in the secondary market, which doesn’t affect the ETF itself.
- When selling on exchange does result in a redemption of ETF shares, it’s usually tax-free to remaining investors. That’s because redeeming in kind involves ETFs merely being unwrapped from the underlying securities.
TAFI and YEAR: Potential Strategies for Employing Tax-Loss Harvesting
For investors seeking to accrue losses before year-end, AB’s short-duration ETFs could be a natural home for tax-loss proceeds. Those seeking a strategy that can help limit duration risk with a focus on after-tax return and income may want to consider the AB Tax-Aware Short Duration Municipal ETF (TAFI) or AB Ultra Short Income ETF (YEAR). For more information on AB’s ETFs, visit www.ABFunds.com/go/ETFs.
Not to be treated as tax advice. Please speak with a professional tax advisor.
Investing in ETFs involves risks, including loss of principal.
Investors should consider the investment objectives, risks, charges and expenses of the Fund/Portfolio carefully before investing. For copies of our prospectus or summary prospectus, which contain this and other information, visit us online at abfunds.com or contact your AB representative. Please read the prospectus and/or summary prospectus carefully before investing.
TAFI—Bond Risk: The Fund is subject to the same risks as the underlying bonds in the portfolio, such as credit, prepayment, call and interest-rate risk. As interest rates rise, the value of bond prices will decline. Below-Investment-Grade Securities Risk: Investments in fixed-income securities with lower ratings (aka “junk bonds”) are subject to a higher probability that an issuer will default or fail to meet its payment obligations. These securities may be subject to greater price volatility due to such factors as specific municipal or corporate developments and negative performance of the junk bond market generally, and may be more difficult to trade than other types of securities. Municipal Market Risk: Economic conditions, political or legislative changes, public health crises, uncertainties related to the tax status of municipal securities or the rights of investors in these securities may negatively impact the yield or value of a municipal security. Tax Risk: The US government and Congress may periodically consider changes in federal tax law that could limit or eliminate the federal tax exemption for municipal bond income, which would in effect reduce the income shareholders receive from the Fund by increasing taxes on that income. Derivatives Risk: Derivatives may be more sensitive to changes in market conditions and may amplify risks. New Fund Risk: The Fund is recently organized, giving prospective investors a limited track record on which to base their investment decision.
YEAR—Below Investment Grade Securities Risk: Investments in fixed-income securities with lower ratings (a/k/a junk bonds) are subject to a higher probability that an issuer will default or fail to meet its payment obligations. These securities may be subject to greater price volatility due to such factors as specific municipal or corporate developments and negative performance of the junk bond market generally and may be more difficult to trade than other types of securities. Credit Risk: A bond's credit rating reflects the issuer's ability to make timely payments of interest or principal - the lower the rating, the higher the risk of default. If the issuer's financial strength deteriorates, the issuer's rating may be lowered and the bond's value may decline. Derivatives Risk: Derivatives may be more sensitive to changes in market conditions and may amplify risks. Foreign (Non-US) Risk: Non-US securities may be more volatile because of political, regulatory, market and economic uncertainties associated with such securities. Fluctuations in currency exchange rates may negatively affect the value of the investment or reduce returns. These risks are magnified in emerging or developing markets. Inflation Risk: Prices for goods and services tend to rise over time, which may erode the purchasing power of investments. Interest-Rate Risk: As interest rates rise, bond prices fall and vice versa, long-term securities tend to rise and fall more than short-term securities. Investment Securities Risk: To the extent the Fund invests in other funds, shareholders will bear to layers of asset-based expenses, which could reduce returns. Leverage Risk: Trying to enhance investment returns by borrowing money or using other leverage tools magnify both gains and losses, resulting in greater volatility. Market Risk: The market values of the portfolio’s holdings rise and fall from day to day, so investments may lose value. New Fund Risk: The Fund is a recently organized, giving prospective investors a limited track record on which to base their investment decision.
The S&P 500 Index is a stock market index tracking the stock performance of 500 large companies listed on stock exchanges in the United States. The Bloomberg US Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. The ICE AMT-Free US National Municipal Index measures the performance of investment-grade municipal bonds that are exempt from U.S. federal income tax and the Alternative Minimum Tax (AMT). Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
AllianceBernstein ETFs are distributed by Foreside Fund Services, LLC, in the US only.
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The example used is hypothetical and not representative of any actual investment. In 2022, a 20% capital gains tax rate is applicable to persons with a total taxable income as follows: a single person with >$459,750; married filing separate >$258,600; head of household >$488,500; and married filing jointly >$517,200. Lower taxable income would have a lower capital gains tax rate. No state capital gains tax is assumed in this example.
RMT-448605-2023-10-30