PIMCO Education

Tax Loss Harvesting – A Tactical Opportunity

John Nersesian, head of Advisor Education, provides a primer on tax loss harvesting— a strategy that can help advisors alleviate their clients’ tax burden and improve their balance sheets. Interested in additional advisor and investor resources? Visit pimco.com/yearendplanning

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Text on screen: PIMCO

Text on screen: PIMCO EDUCATION –TITLE – Tax Loss Harvesting – A Tactical Opportunity with host John Nersesian (7 minutes)

Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement. This video is intended for investment professionals, but has been made generally available for informational purposes only.

Text on screen: John Nersesian, Head of Advisor Education

John Nersessian: Hi. I'm John Nersessian, head of Advisor Education at PIMCO. Today we're going to be talking about a specific tactical opportunity around tax loss harvesting. Recent market volatility suggests that there may be an opportunity to bring this valuable guidance

Graphic Title: Capital gains/losses recognition

Description: This graphic consists of two boxes, describing how capital gains and losses are calculated. One box is titled “Short-term transactions,” while the other is titled “Long-term transactions.” Each box contains a particular equation that results in a net position, over short-term and long-term transaction periods, respectively. The short term transaction box displays the following text beneath the title: Total short-term gains minus total short-term losses = net short-term position. Underneath the long-term transaction box, is text displaying: total long-term gains minus total long-term losses = net long-term position.

to your clients to produce intended tax advantage.

Let's start with a quick refresher on this capital gain and loss harvesting methodology, to take advantage of those opportunities when they exist in the marketplace.

Of course, we start first with short-term gains against short-term losses. We net those two together to come up with a net short-term position.

We then move the methodology over to the long-term position, those assets held in excess of 12 months, and we net out gains against losses there as well.

Graphic Title: Capital gains/losses recognition

Description: This graphic consists of two boxes, describing how capital gains and losses are calculated. One box is titled “Short-term transactions,” while the other is titled “Long-term transactions.” Each box contains a particular equation that results in a net position, over short-term and long-term transaction periods, respectively. The short term transaction box displays the following text beneath the title: Total short-term gains minus total short-term losses = net short-term position. Underneath the long-term transaction box, is text displaying: total long-term gains minus total long-term losses = net long-term position.

Finally, we pull the two together, and we net out our net short-term position against our net long-term position utilizing that net number in a variety of different ways.

If we have a gain at the end of the day, that gain is going to be taxed based on the relative holding period. If, however, that netting methodology produces a loss, our clients of course can use losses, dollar for dollar, against realized gains. Anything above and beyond can be used up to $3,000 a year against ordinary income. Anything above that amount gets carried forward indefinitely.

Let's quickly review our tax rates for 2022, as they've adjusted for inflation factors.

Graphic Title: Capital gains/losses recognition

Graphic Subtitle: Ordinary income and capital gain tax rates— 2022

Description: This graphic consists of a table of ordinary income tax rates, for married (filing jointly) and single households. It lists rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%. For the lowest tax bracket, 10%, single households pay 10% on the first $10,275 earned, while married households pay 10% on the first $20,550 earned. For the median tax bracket, 24%, single households pay 24% on $89,075 - $170,050 earned, while married households pay 24% on $178,150 - $340,100 earned. For the highest tax bracket, 37%, single households pay 37% on $539,900+ earned, while married households pay 37% on $647,850+ earned.

We know that we have a minimal rate of 10% for families filing jointly up to $20,000. The maximum federal income tax rate is 37% today. And that affects families at approximately $650,000.

We do want to remind everybody, of course, about the more favorable long-term capital gain rate structure that exists in the federal code today.

Graphic Title: Capital gains/losses recognition

Graphic Subtitle: Ordinary income and capital gain tax rates— 2022

Description: This graphic consists of a table of capital gains tax rates, for married (filing jointly) and single households. It lists rates of 0%, 15%, and 20%. For the lowest tax bracket, 0%, single households pay 0% on the first $41,675 earned, while married households pay 0% on the first $83,350 earned. For the median tax bracket, 15%, single households pay 15% on $41,675 – $459,750 earned, while married households pay 15% on $83,350 - $517,200 earned. For the highest tax bracket, 20%, single households pay 20% on $459,750+ earned, while married households pay 20% on $517,200+ earned.

We have the 0% rate up to 83,000, a 15% rate up to 517, and then the maximum long-term capital gain rate remains very favorable at 20% for income above 517,000.

Now, of course, we do need to factor in the two Obamacare taxes, 0.9% against earned income, 3.8% against passive forms of income, including investment-related activity. Both of these affect families at $250,000 and above. Let's now have a conversation around an illustration to demonstrate the benefits of tax loss harvesting in a hypothetical client scenario. Here are our assumptions.

Graphic Title: Benefits of tax loss harvesting

Graphic Subtitle: Illustration

Description: This graphic consists of a box laying out assumptions for an example illustrating the benefits of tax loss harvesting. The box poses the following assumptions: the ordinary income of the married household is $800,000, it’s short term capital gain distributions are $20,000, it’s realized long term capital gains are $25,000, and its holdings are $600,000 in ABC fund, with a cost basis of $650,000 (short term).

Our family files jointly with an annual income of $800,000. This family has received short-term capital gain distributions during the year of $20,000. They also realized a long-term capital gain in their portfolio for $25,000. And this family holds a position today that was originally purchased at 650, but current market price suggests $600,000 — or an unrealized loss of $50,000.

A potential tax loss scenario might be,

Graphic Title: Benefits of tax loss harvesting

Graphic Subtitle: Illustration

Description: This graphic consists of a diagram illustrating a given married client household using the strategy. The diagram shows the client household selling their ABC fund holdings and buying $600,000 in XYZ fund, for a short term capital loss of $50,000. While this graphic shows the assumptions of the example, the next graphic will illustrate the results of the example.

the investor sells the original position for 600, reinvests those proceeds into a similar security, but not identical, maintaining their exposure in the intended asset class, but booking a $50,000 loss for tax benefits.

What are the resulting implications? Let's go through them.

Graphic Title: Benefits of tax loss harvesting

Graphic Subtitle: Illustration

Description: This graphic consists of a box laying out the results of an example illustrating the benefits of tax loss harvesting, and a diagram illustrating a given married client household using the strategy. It is a follow-on graphic, adding to the previous graphic. The box displays the given results, using the example from the prior graphic. The results are: A reduction of $20,000 in short term capital gains, at 40.8% ($8,160), a reduction of $25,000 in long term capital gains, at 23.8% ($5,950), a reduction of $3,000 ordinary income at 37.9% ($1,137), and a loss carryforward of $2,000. The diagram next to the box is identical with the previous graphic, showing the client household selling their ABC fund holdings and buying $600,000 in XYZ fund, for a short term capital loss of $50,000.

Number one, the client offsets their $20,000 short-term capital gain, which produces a tax benefit of $8,000. They also offset their $25,000 realized long-term capital gain, saving another $6,000. They use $3,000 against ordinary income, producing an incremental benefit of just over $1,000. And the client retains a loss carry-forward of $2,000 to use in future years.

Now, while the immediate tax benefits of a tax loss harvesting scenario might be obvious,

Graphic Title: Benefits of tax loss harvesting

Graphic Subtitle: Illustration

Description: This graphic consists of a box declaring the potential impact of reducing aggregate gross income through offsetting gains. The box displays potential impacts using the example from the prior graphics. The potential impacts are: marginal bracket creep, alternative minimum tax exemption amount, qualified business deduction for pass through business owners, social security taxation, and Medicare premiums.

there are some additional benefits that may be less obvious. Those include the opportunity to reduce bracket creep, where a gain might force our client into a higher marginal bracket. Clients who might be subject to the AMT. That exemption amount, of course, is subject to a phase-out for higher-income individuals.

How about closely-held business owners, who might take advantages of the QBI or 199A deduction, which of course is available based on their AGI limits. And then finally, social benefits, including the taxation of social security and the Medicare premiums paid, are all determined based on our client's adjusted gross income.

Tax loss harvesting provides the benefit of an immediate tax reduction, but ancillary benefits in lowering our clients' adjusted gross income.

Now, in this process of realizing losses for tax benefits, we have to be aware of or conscious of the wash loss sale rule.

Graphic Title: Understanding wash sale rules

Graphic Subtitle: Illustration

Description: This graphic depicts a timeline and a table describing the parameters for wash sale securities rules. The rules concern the period of time during which a security or something identical can’t be repurchased without losing the ability to deduct the loss. The timeline displays a sixty-one-day period. It shows that if an asset is held for 30 days, and sold on the 30th day, it can’t be repurchased with the deduction included for another 30 days. The table below the timeline has three columns: the first column concerns the asset sold at a loss, the second column the asset purchased after the time has elapsed, and the third column indicates the purchases eligibility for the wash sale rule. The table indicates that assets purchased must be substantially identical to the assets that are sold. To provide an example from the table, if a mutual fund from Company A is sold, and a different fund from Company A is purchased, the wash sale will not be triggered. However, the table shows, if an individual table account is sold, and the same position is repurchased in a spouse’s account, this does trigger the wash sale.      

You know how it works. It's that 61-day window, 30 days before the trade date, 30 days after, that prohibits us from buying or selling that security in that window, in order to utilize the realized loss for tax advantages.

Now, there are a number of ways around the tax loss rule, and the opportunity to use these losses for the intended tax benefit. Most obviously, our client can sell that position at a loss and wait the required 31 days before re-establishing the position. The client might sell one security and buy something similar, but not identical. I sell one automobile stock, I buy a similar automobile stock. I liquidate an investment municipal bond fund and I buy a similar, but not identical, municipal bond fund in order to maintain my exposure but to realize the loss.

Let's now turn our attention to how we communicate this value to our clients. I think it's so important for us to be proactive, particularly during this period of market volatility, to bring valuable ideas to our clients that help improve their financial outcomes.

Description: This graphic depicts a box listing the benefits of tax loss harvesting in the current market. The box is titled “Harvesting Losses in Current Market.” The box lists six benefits. These are: Produce tax benefits by offsetting capital gains, reducing aggregate gross income, can be executed during portfolio rebalancing for efficiency, opportunity to reposition portfolios to capitalize on current opportunities, overcome behavioral bias of loss aversion, demonstrate professionalism through proactive advice – your alpha, and demonstrate empathy beyond “stay the course”.

Harvesting losses in this current market environment can obviously produce tax benefits by offsetting capital gains and lowering their AGI. It can be executed as part of a portfolio rebalancing methodology to align our clients' portfolio exposures to their intended policy. It can help clients overcome this concept of loss aversion, that status of inactivity where clients are reluctant to make effective or useful changes in their portfolio strategies.

But maybe there's an additional benefit from the advisor's perspective at— as well. It demonstrates empathy. It demonstrates forward thinking. It demonstrates our ability to go beyond just stay the course and to bring valuable, actionable ideas to our clients that provide associated benefits.

I hope this conversation around tax loss harvesting has been beneficial.

Text on screen: To learn more visit pimco.com/advisoreducation or speak with your Account Manager

If you'd like to learn more about that, or any of the other concepts we've discussed today, please feel free to visit our website or, of course, to contact your local PIMCO account manager.

Text on screen: PIMCO

Disclosure


IMPORTANT NOTICE:
Please note that this video contains the opinions of the manager as of the date recorded, and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.

All investments contain risk and may lose value.

PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.  Any tax statements contained herein are not intended or written to be used, and cannot be relied upon or used for the purpose of avoiding penalties imposed by the Internal Revenue Service or state and local tax authorities. Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.                                

The views and strategies described may not be appropriate for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal advisor regarding such matters. Please contact your account manager for further information.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2022, PIMCO.

Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626.

CMR2022-0913-2416910

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