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Financial Industry Insights from Advisors Asset Management
On December 02, 2013
Viewpoints from AAM - Tax Swaps, Bananas and the Perfect Storm
You know what they say is common about bananas and empty airline seats: their value to the owner is time sensitive. After a certain time they either spoil or fly empty; either scenario makes them both worthless. The same can be said about tax swaps. If losses are not realized by the end of the year, they cannot be used on this year’s tax returns.
I have heard it said that this year is the “Perfect Storm” for tax swaps. It has probably been 15 years since the equity markets have rallied this much while bonds values have experienced significant drops. Investors considering taking advantage of this “Perfect Storm” should consider moving sooner rather than later as the market typically deteriorates going into year-end.
In a tax swap, an investor sells a security in which there is a loss and then reinvests in another security that is not “substantially identical” (to avoid having the loss disallowed under the “wash sale” rules). The loss on the sale can be used to offset gains realized on other capital investments.
Besides the obvious tax advantage to the client, tax swapping provides a great opportunity to restructure and/or rebalance a client’s portfolio. Many clients do not want to take gains. By trading an asset with a gain, such as equity mutual fund, and pairing it against a loss, for example, in a long-term bond fund, the client can now restructure the portfolio while using the loss to offset tax liability that the client would otherwise incur on the gain.
In this example, if the client desired a more defensive bond exposure, the proceeds can be reinvested into a fixed income UIT (unit investment trust) or individual bonds with shorter durations, which also provide transparency and definition. Other reasons for restructuring can be to alter credit quality or decrease exposure to certain sectors.
If you have not had the opportunity to execute tax swaps, they understandably can appear complicated. In reality, they are fairly easy to do. I believe there are two main steps.
1) Know the client’s needs and objectives
2) Review the portfolio in its entirety
By reviewing the entire portfolio, you will be able to choose the best investments to trade to achieve the tax results desired, and at the same time take advantage of the opportunity to restructure the portfolio to fit the client’s objectives.
AAM has the products and the expertise from individual investments to portfolio reviews to assist in this process. You and your client should also consult your own tax advisors before engaging in any tax swap.
I wish you a happy holiday season; for me, I am going to do my swaps and shopping early. It is a lot less stressful.
If you are a registered financial advisor and you would like to learn more about preparing your clients’ portfolios for tax swap season, please email us at eservices@aamlive.com and we will send you our FREE Tax Swap Q&A Whitepaper.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.
Advisors Asset Management, Inc. and its representatives do not provide tax advice. Laws applicable to tax-related investment strategies can be complex and are subject to change. You should consult your own tax advisor before making any tax-related investment decisions.
CIRCULAR 230 DISCLOSURE: Any statements regarding tax matters made herein cannot be relied upon by any person to avoid tax penalties. This communication was prepared in connection with the marketing of the transactions described herein. Taxpayers should seek advice from an independent tax advisor regarding the matters described herein based on the taxpayer’s particular circumstances.
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