Higher Treasury yields have pushed bond prices lower, leaving some investors with unrealized losses — and a potential tax-planning opportunity.
The 10-year and 30-year Treasury yields hit their highest levels in 24 years this week, reaching levels not seen since 2002. Yields retreated Friday following a surprisingly weak jobs report.
Investors who bought individual bonds, bond mutual funds or exchange-traded funds when yields were lower may now be sitting on losses. Financial and tax professionals say selling some of those investments in taxable brokerage accounts may help offset taxable gains elsewhere in a portfolio.
“It may be a great opportunity to actually dispose of those bonds that have unrealized losses, so that you could make those losses into real capital losses that you can use against other capital gains,” said Marianela Collado, senior wealth advisor and CEO at Tobias Financial Advisors in Plantation, Florida.
The strategy is called tax-loss harvesting: An investor sells an investment for less than its purchase price, realizes the loss and uses it to offset capital gains.
“Tax-loss harvesting opportunities should be reviewed regularly. They can provide a tax-efficient way to offset realized capital gains from a strong equity market while refining portfolio allocations,” said Collado, who is a certified financial planner, certified public accountant and a member of CNBC’s Financial Advisor Council.
Start with this tax-loss harvesting checklist
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Many investors wait until December to consider tax-loss harvesting. Experts say reviewing taxable fixed-income holdings now may offer more flexibility before the year-end rush.
Here are four steps to consider:
- Find losses in taxable brokerage accounts. Tax-loss harvesting generally does not provide a tax benefit in tax-advantaged accounts such as 401(k)s and IRAs.
- Sell an investment trading below its tax cost basis. A paper loss alone does not count; the investment must be sold to realize the loss.
- Use the loss to offset capital gains. If capital losses exceed gains, investors may generally use up to $3,000 of net capital losses to reduce ordinary income for the year, or $1,500 for married taxpayers filing separately. Unused losses can generally carry forward.
- Reinvest thoughtfully. The goal is to stay invested if that remains appropriate — not to try to time the market.
Avoid the wash-sale rule
Investors who sell an individual bond, bond fund or ETF for a loss must be careful about what they buy next.
The IRS wash-sale rule can disallow a tax loss if an investor buys the same or a “substantially identical” security within 30 days before or after the sale.
The rule can apply even if the replacement investment is purchased in an IRA or Roth IRA. Investors should review transactions across all accounts before selling, experts say.
Joseph Gotelli, a vice president and senior portfolio manager at American Century Investments, a global asset manager, says that does not necessarily mean staying out of the bond market. An investor may be able to move into a different fixed-income fund that fits their goals without buying a substantially identical investment, he said.
Still, making that determination can be complicated, so consulting a tax professional may help.
Don’t sell simply for a tax break
Tax-loss harvesting may not make sense for everyone.
Investors with a ladder of individual bonds who are comfortable with their income and plan to hold bonds to maturity may not need to sell, Collado said. As bonds mature, they can reinvest the proceeds into newer, higher-yielding issues.
For others, higher yields may be an opportunity to reassess their fixed-income allocation.
“At the yield levels we’re seeing today … investors have an opportunity not only to consider tax-loss harvesting, but also to rebalance their portfolios,” Gotelli said.
Experts say that review should include an investor’s time horizon, income needs, interest-rate risk and diversification.
“Anytime there’s a drop in a sector of the market, it’s a good time to revisit performance, quality and yield across the board,” Collado said.
Investors in their 30s may have more time to ride out bond-market volatility than those nearing retirement, said Brant Wong, head of retirement solutions at Principal Asset Management, the investment management arm for Principal Financial Group.
Before making a trade, weigh transaction costs, tax consequences and whether the move changes your portfolio’s risk level, Collado said. A tax loss can be valuable, but it should support — not dictate — an investment strategy.
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