Play offense: Tax-loss harvest bond funds to help lower tax bills

• With the recent rise in interest rates, 99% of Core and Core-Plus bond funds have a negative price return.¹
• On average Core Bond funds are down 20% on a price return basis over the 3-year period ending Aug. 31, 2023! Learn why it’s price return, not total return, that matters for taxes.²
• The biggest opportunity for clients looking to limit taxes and reposition portfolios could be tax-loss harvesting in fixed income.

2023 is the third-consecutive year bonds have been down, and advisors are having to face tough end-of-year conversations with clients. This year, 99% of Core and Core-Plus Bond fund price returns are negative for the 1-, 3- and 5-year periods, with the average Core Bond fund down 20% over 3 years. ³ But it’s not all doom and gloom. Taxes are one of the few factors in a portfolio that advisors can exert control over, whereas pretax returns are among the hardest to predict. This year presents a significant opportunity to tax-loss harvest those losses and offset gains to ultimately help lower clients’ tax bills in 2024, and potentially beyond.

 Tax loss harvesting is a strategy of selling investments for a loss and using those losses to reduce tax liability on other capital gains in the portfolio and/or to offset up to $3,000 in ordinary income. These losses can be carried forward and realized in future years as well. ⁴

In 2022, bond funds saw negative price returns as the U.S. Federal Reserve embarked on a tightening cycle to reduce the impact of inflation on the economy. As a result, bond mutual funds saw $531 billion of outflows and bond ETFs benefited from $197 billion in inflows. ⁵

The Fed continued to tighten in 2023, raising interest rates four times with a pause at the June and September meetings. Long-term rates continued to climb in September and October, driving Treasury yields to the highest levels since 2006. ⁶ (Read more about why rates are up and what it could mean for investors | iShares – BlackRock)

As rates rose in 2023, bond prices went down further and more bond funds experienced price losses (a bond’s price moves inversely to its yield, which has generally risen in tandem with the fed funds rate).⁷

Bond total returns include any changes in the price of the bond plus income distributions. The price return just includes the change in bond prices. Said another way, to find price return, you subtract capital gains and income distributions from total return. While income and capital gains are taxed in the current tax year, the price return represents a future tax liability. Funds with negative price returns could be candidates for tax-loss harvesting.

Since bond funds tend to distribute the bulk of their return in income distributions, their price return is usually well below their total return. This is the critical insight that can unlock tax-loss harvesting opportunities.

Step 1: Identify client funds with price losses and consider selling them 

Advisors may recommend clients consider harvesting losses from their bond funds with negative price returns. Check out BlackRock’s Tax Evaluator tool to help you identify funds with negative price returns. The tool shows the size and pending capital gain distribution for 7,000 funds and can help advisors quickly identify funds with price losses over 1-, 3-, 5-, and 10-year periods.

Hypothetical example: $5 million initial investment in a bond fund with a $1 million loss.

Step 2: Consider reinvesting to maintain clients’ asset allocation

After harvesting losses in clients’ bond funds, take the opportunity to reassess their bond investments. If the bond mix looks right, keep existing exposures, and consider allocating the proceeds of the sale to a low-cost iShares ETF in the same Morningstar Category. The iShares Correlation tool can help find a comparable fund and make sure there is not too much overlap to trigger the wash sale rules.⁸

Hypothetical example: Put $4M back to work in your portfolio.

Step 3: Potentially lower your clients’ April 2024 tax bills

Help offset gains with losses now or in the future, reducing taxes owed, or help offset up to $3,000 per year in ordinary income.⁹

Hypothetical example: Offset $1M portfolio gain or ordinary income.

The impact of taxes should be a year-round conversation with clients and the CPAs within your network. BlackRock can be your partner in delivering thoughtful tax efficient portfolios through our extensive platform of strategies, technology, and tools such as our Tax Evaluator.