A bespoke approach to tax loss selling

Markets
12-06-2023

Discretionary PM outlines how he approaches the practice year-round and highlights where he sees the greatest potential for gain in tax loss selling season

November 30, 2023

Tax loss selling often begins with a calendar reminder. Somewhere in November, advisors start poring over clients’ non-registered accounts looking for unrealized losses that can help alleviate a tax burden or offset a tax bill coming from any realized gains. It’s a bread-and-butter value add for advisors, using technical skills to manage a client’s taxes.

Kevin Burkett thinks there’s an opportunity to demonstrate that value year-round. The portfolio manager at Burkett Asset Management looks for opportunities to realize losses throughout the year. When he does that, however, he tries to take a more holistic view, seeing how this particular sale can fit into a client’s overall plan.

“The traditional approach is to say ‘let’s find stocks that have fallen the most, and sell those stocks over a year, and when you take that simplistic approach you are potentially missing out on a recovery in those companies’ shares,” Burkett says. “You want to have in your scope a view as to whether you want to remain invested in that company and hope they realize share price recovery. I wouldn’t say what we do is drastically different than the conventional approach. I think we just try to zoom in more and consider a broader range of factors to get the client the best outcome, and to show the client that we’re thinking about their situation in a pretty deep way.”

Burkett notes a few considerations his team keeps in mind around tax loss sales. Holding companies, for instance, may have very different fiscal years. Therefore he and his team make note of when any sales needs to happen within the context of a particular holding company’s setup.

The rules around capital losses are crucial, too. Investors must adhere to the superficial loss rule, wherein a security is sold by a person and a party affiliated with that person — such as their spouse or holding company — buys the identical security. As well, the same position can’t be entered within 30 years of its disposition. Burkett educates his clients on these rules, as they might re-enter the same position via their spouse’s account or a holding company out of fear of missing out on a gain.

Burkett also has to combat that FOMO when tax loss selling comes. He notes, however, that given the incredible diversity of similar ETFs now available on the market, he can exit certain positions at a realized loss, move into another position with similar overall exposure, and not trigger any violations of the rules. That can keep his clients participating in any potential share price recovery and improving their overall tax efficiency.

After a volatile few years on the market, Burkett sees the greatest potential for tax loss selling advantages in fixed income. After three years of negative total returns on most fixed income, there is a significant opportunity to exit positions at a loss while moving into positions with very similar overall exposures, risk ratings, and potentially more advantageous yields.

Higher yields on bonds, however, add to the interest income portion of a client’s tax exposure. Burkett thinks that tax-sensitive clients could actually benefit from some of the lower-yield bonds issued during 2020 and 2021, which are coming to maturity soon. Those bonds are currently trading at a discount, and between the outlook for broad improvement on the bond market and the likely return they will provide at maturity in the form of capital gains, they could be a way to realize a tax loss on fixed income positions now and shift some interest income tax bills over to the more efficient rates delivered by capital gains.

Burkett notes that sometimes the temptation to realize a loss for tax sale purposes can be great, but argues that if the right alternative product doesn’t exist for clients, it might not be right to exit that position. Advisors approaching tax loss selling need to be careful and mindful of how exiting a position at a loss, only to add the same position at a higher cost down the road will make them look.

“If you sell and realize a loss, and you don’t put that in the market, you might get lucky, but I don’t know if clients are going to give you credit. I think they will hold it against you if you get unluck,” Burkett says. “You’d hate to have a client statement that shows you sold a position and bought it back much more expensively, I think if you can point to what you did with the funds in the interim, and show that you continued to participate, that’s a better story for your client than simply saying ‘I left it as cash for the required 30 days and then bought the position back.’”



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