Partner, Head of Fixed Income
The yield on the 10-year U.S. Treasury has hit 5%, a level not seen since 2007, after flirting with the milestone over the past week. This latest push higher in rates was driven by several factors, including uncertainty surrounding the Fed’s next move, increasing Treasury supply, stronger than expected employment numbers, confusion in Washington, and rising inflation expectations.
As rates have moved higher, bond prices have moved lower—that’s the way bond math works. In some bond markets, the price is the lowest in over a decade. While this is not great news from a total return perspective, it does offer an opportunity for taxable investors to harvest losses in their bond portfolio to offset gains that they may have recognized, or plan to recognize, in other sectors. Especially for municipal bond investors in the highest marginal tax bracket, the recognition of losses can be a valuable tool to reduce their current or future tax liability.
When recognizing bond losses, it’s important to keep the following factors in mind.
- Be careful not to violate the IRS Wash-Sale Rule. The Wash-Sale Rule will disallow a current tax deduction if an investor sells a bond at a loss and buys back a similar or identical security within 30 days. We recommend checking with your tax advisor for suitability and financial advisor to effectively implement as the IRS definition of “similar” is not crystal clear.
- Use this as an opportunity to rebalance your overall portfolio. To the extent that you are contemplating a shift in allocation, recognizing losses in part of the portfolio may facilitate that shift. We discussed this in greater detail during the Q4 Market Outlook webinar, which can be replayed from this link.
- Don’t wait for the year-end rush. Typically, investors and financial advisors will wait until December to generate losses. The new issue municipal bond supply tends to decline in November and December, so to avoid the scuffle over quality bonds, we would recommend starting the process sooner rather than later.
- When repurchasing municipal bonds, be aware of the de minimis tax rule as you do your tax planning. This rule states that if a bond is purchased at a small enough discount to par, the accretion back to par at maturity will be treated as a capital gain and not ordinary income. In the last few years, given the decline in bond market prices, the amount of bonds subject to this tax provision has increased. We would recommend checking with your tax advisor and financial advisor for implementation.
- Be sure your advisor is implementing these transactions with as little disruption to your bond market strategy as possible. Given the volatile nature of the recent market, you want to make sure that bonds are sold and purchased as simultaneously as possible. You want to maintain your appropriate municipal bond allocation during the transaction period, minimizing temporary cash or cash-like exposure.
Bond market volatility is on the rise and year-to-date returns are negative. While we remain constructive on fixed income in the long term, the recent decline in bond price presents an opportunity to reduce your tax liability. After all, at the end of the day, it’s what stays in your pocket after the taxman man comes that counts.
Information presented is for educational purposes only, not personalized investment advice. Please be sure to consult with a tax professional before implementing any investment strategy. Investment Advisory Services offered through Fidelis Capital Partners, LLC a Registered Investment Advisor with the U.S. Securities & Exchange Commission. Registration does not imply a certain level of skill or training. Please refer to our ADV brochure found at https://adviserinfo.sec.gov/ for a complete description of services and fees.
