Maximizing Tax Savings with Muni Bonds

How today’s market conditions may create tax opportunities in muni bonds

Investors have long turned to municipal bonds for the potential benefit of tax-exempt income. Yet many investors may be surprised to learn they could also present one of the most overlooked opportunities for tax loss harvesting this year. Rising interest rates and persistent inflation have created favorable conditions to consider harvesting losses. Nearly all national intermediate duration municipal bond funds have posted price losses over the past 5 years, indicating ripe opportunity to harvest losses in client accounts.¹ This has created a potentially powerful opportunity: clients may seek to lower their tax bills and reposition portfolios into more tax-efficient exposures, all without leaving the asset class.

Furthermore, with returns varying widely across strategies, selecting the right exposure can be critical. The iShares High Yield Muni Active ETF (Ticker: HIMU) and the iShares Short Maturity Municipal Bond Active ETF (Ticker: MEAR) demonstrate how active managers might add value through security selection and duration positioning in differing market environments.

Bond funds may be ripe for tax loss harvesting

The mechanics of municipal bond funds can make them well suited for tax loss harvesting because the primary driver of total return comes from income, rather than price appreciation. Total return refers to the combination of all income received (such as interest payments) and any change in the price of the investment over time, while price return reflects only the change in price, excluding income. For example, the average intermediate muni bond manager has posted negative price returns over the past five years, even though total returns have been positive. Total return has remained positive because the interest income generated by these bonds has more than offset the decline in prices. As a result, price declines may create an opportunity to harvest losses without reducing the tax exempt income that investors rely on, provided they remain invested in municipal bonds as an asset class.

Investors should be aware that tax loss harvesting strategies are subject to wash sale rules, which may limit the ability to realize a loss for tax purposes if a substantially identical security is purchased within 30 days before or after the sale.²

For advisors, this dynamic presents a unique opportunity: losses may be realized to offset taxable income or realized gains elsewhere, while portfolios may be repositioned into strategies that better align with clients' current after-tax goals. Tools such as BlackRock’s Tax Evaluator aim to make it easier to identify where those opportunities could exist across client accounts.

Market backdrop: challenges that may create opportunity

Rising interest rates and continued inflationary pressures have weighed heavily on fixed income markets over the past several years.

Category average 5-year price returns are deeply negative across High Yield Muni funds (-10.6%) and Intermediate Muni funds (-6.7%) on a cumulative basis. Tax equivalent yields are at 6.04% and from a total return perspective, 5-year returns stand at +15.11% and +4.35% respectively.³

Category Performance Snapshot

The same market volatility that has pressured municipal bond prices lower has also caused yields to rise. Bond prices and yields have historically, moved in opposite directions. When prices have fallen, yields, which represent the income investors earn as a percentage of the bond’s price, have increased. Today’s higher yields may provide investors with the opportunity to earn more income from new investments than in recent years.

Importantly, let’s not forget the overall value that these strategies may add. Historically, High Yield Municipal Bonds have appealed to investors in higher tax brackets due to their relatively elevated tax-equivalent yields compared to other high-yield sectors such as corporate bonds, while generally exhibiting lower credit risk over time.

Redeploying losses with iShares muni solutions

For advisors redeploying harvested losses, the choice of investment vehicle may significantly affect tax outcomes. While investors may move between mutual funds and ETFs in various combinations, it is important to consider how each type of fund handles taxes, particularly capital gains distributions. This is especially relevant for municipal bond investors, who tend to focus on maximizing after-tax returns.

ETFs have generally offered greater tax efficiency than mutual funds because of the way they are structured. When investors buy or sell shares of an ETF, most transactions occur on the exchange rather than within the fund itself. This structure can help reduce the number of taxable events inside the fund, which may result in fewer capital gains distributions to investors. The numbers tell the story: in the Morningstar U.S. Muni Intermediate category, only 19% of ETFs distributed a capital gain over the past five years, compared to 57% of mutual funds. A similar pattern appears in high-yield munis, where 25% of ETFs paid a capital gain in the past 5 years versus 38% of mutual funds. For advisors, factoring in these differences can help deliver more tax-efficient outcomes for clients.

iShares has the largest platform of municipal bond ETFs (17) ranging in geography, duration, maturity and credit quality, in addition to the active and index portfolio management styles.³ The breadth of options on the platform gives investors more choice and flexibility to help manage tax liabilities. Not only may you find more tax efficient structures via ETFs with iShares, but you may also rely on experienced portfolio management teams. Active management can play a particularly important role in navigating the high-yield municipal bond market, where complexity and fragmentation can create opportunities for skilled managers.

Using active management may help achieve consistent results in the variable muni bond market.

HIMU vs US Fund High Yield Muni Category Performance of 9/30/2025

A timely opportunity

Municipal bonds can play an important role in year-end tax planning, particularly for investors looking to manage taxable income or realize losses for tax purposes. iShares offers a broad range of municipal bond ETFs that may help investors and their advisors choose among different maturities, credit qualities, and investment strategies to align with their tax and income goals. Advisors may take action by reviewing client portfolios and utilizing BlackRock tools such as the Tax Evaluator to help uncover opportunities. By turning losses into tax-smart opportunities, advisors may seek to strengthen client outcomes with iShares ETFs.