INSIGHTS

On November 03, 2014

Viewpoints from AAM - Tax Swap Season is Here

A bond tax swap allows and investor to take advantage of a tax loss while maintaining or enhancing the income, credit quality, call protection or duration of their bond portfolio. While the opportunities in this year’s swap season may not be as obvious as last season, the opportunity still exists and we encourage investors to move sooner rather than later. Liquidity typically deteriorates in December and swaps remain most effective when the bid-offer spreads are tight (intense price competition on both the buyers’ and sellers’ side) so now is the time to consider implementing a swap strategy to address anticipated tax liabilities.

Virtually any type of bond can be swapped so long as an appropriate replacement can be found, but remember the replacement bond must be substantially different than the bond to be swapped to avoid disallowance of the loss under the “Wash Sale Rule.” As an example, if there is a loss on a bond one can sell that bond and simultaneously purchase a bond which provides the same investment objective to the portfolio but is “substantially different.” The standard rule of thumb is two of the following three characteristics below must be different and it’s important to ask a tax advisor for input.

• Coupon Rate
• Issuer
• Maturity

This year we’ve seen positive performance out of most asset classes so the swap opportunity may be credit driven in which you may have had a downgrade, or an individual credit that has performed poorly. Swapping selected holdings into a new credit that fits a risk profile, while improving portfolio credit quality or tactically adjusting duration, may allow a portfolio to be better positioned for the expected rate environment while likely improving portfolio composition. Current market conditions allow for many types of swap opportunities that have the potential to enhance portfolios. A few types of swaps that might be beneficial include:

• Credit Quality Swaps
• Total Return Swaps
• Duration Swaps
• Income Oriented Swaps
• Tax Efficiency Swaps
• Asset Allocation Swaps

With only two months left in 2014, identifying and harvesting losses now should allow you to avoid the challenging markets we typically see in December. This strategy is not only useful for addressing potential tax issues, but allows the potential to improve fixed income composition for the day interest rates do begin to rise.

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.

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.