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Financial Planning > Tax Planning > Tax Loss Harvesting

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Stuart Zimmerman WILLINGLY gives credit to his partners for the success of the firms they’ve built. Zimmerman is particularly proud of Buckingham’s zeal for academic research, tossing out the names of DFA, Fama and French, and Ibbotson in discussing where the firm gets its investment philosophy underpinnings. There’s one other name he drops: Larry Swedroe. Swedroe is a Buckingham principal who serves as director of research and has written numerous books, including The Only Guide to a Winning Bond Strategy You’ll Ever Need (Truman Talley Books 2006). Below is a recent “Bamogram Tax Tip”that Swedroe has drafted to be sent out to BAM Advisor Services’ clients; he stresses that the opinions and comments expressed are his own.

“The conventional investment wisdom on the realization of gains and losses is that in taxable accounts we want to realize losses whenever they are significant and defer gains for as long as possible. An exception to that rule is that we should be willing to realize long-term gains (or short-term gains if we have offsetting losses) if by avoiding them we would allow the portfolio to style drift from its targeted asset allocation. . . There is, however, a situation in which the realization of capital gains would actually increase after-tax returns. . . An investor has a federal income tax rate of 35% and is holding dollars in a taxable account that should be allocated to fixed income securities. After making the appropriate comparison between the return on a municipal bond and the after-tax return on a taxable bond, the investor calculates that the taxable bond provides the higher after-tax rate of return and thus purchases it. One year later, interest rates have fallen significantly. The investor now has a large capital gain on the bond. The investor could hold that bond, and continue to pay a tax of 35% on the interest, or he could sell the bond. By selling the bond the investor converts future interest income that would have been taxed at the ordinary income tax rate of 35% into a long-term capital gain that is taxed at a rate of only 15%. And because there is no wash sale rule on gains, the investor could even immediately buy back the same security. Of course, the loss of the present value of having to pay taxes early and the costs of the transaction should be considered. This strategy of realizing capital gains on taxable fixed-income investments is an unusual example of why the only thing worse than paying taxes is not paying them.”


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