Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Lecture
Posts: 30
Joined: Wed Oct 27, 2021 8:10 am

Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by Lecture »

Hello, in a taxable account, my broker (with a fee based account) wants to harvest some equity gains, but the tax bill (mostly LT but also some ST) will be considerable. To offset that, he proposes selling some Treasury bonds to harvest a tax loss, claiming new bonds (at higher interest rates) will eventually make up the loss.
(Lol, I've got some equity clunkers with a huge loss, but they're in my retirement account!)
For instance, I've got a Treasury bond maturing in 2030, YTM 1.5%. If I sell it now, I'll generate a $3900 loss; that's 11% of what I paid for the bond. Broker says buying 3 mos Treasury bills (currently 2.5%) will eventually make up that loss. Meanwhile, the loss can offset some equity capital gains.
I realize that the actual math, amounts, etc involved are crucial to each case. I also realize, as he says, "You've got to pay the taxes at some point."
My inquiry here is because I did some maths about this, and- at least at the amount of stock being sold, and the 11%/$3900 bond loss - it looks like I'd be better off leaving the bond alone till maturity, and just paying the LTCG tax.
So my general question is really - do you routinely swap out Treasury bonds just to harvest losses, and is this really cost effective in the long run? Thanks.
jebmke
Posts: 25474
Joined: Thu Apr 05, 2007 2:44 pm
Location: Delmarva Peninsula

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by jebmke »

I sell bond funds to harvest losses and put the proceeds in a different bond fund. My economic position is essentially unchanged.

Your underlying issue is
Lecture wrote: Thu Aug 18, 2022 1:24 pm my broker (with a fee based account)
It appears that you have your money with someone who has an incentive to churn your account.
Don't trust me, look it up. https://www.irs.gov/forms-instructions-and-publications
Topic Author
Lecture
Posts: 30
Joined: Wed Oct 27, 2021 8:10 am

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by Lecture »

Well, he's fee based (1% of the equity amount yearly), so churning for commissions is not a concern. The greater concern is whether this harvesting/shuffling (ie, 'active management') is really doing anything beyond doing nothing, especially in regard to his approach to the Treasury bonds.
ScottSmith
Posts: 7
Joined: Sat Dec 31, 2011 7:04 pm

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by ScottSmith »

I believe bond interest is charged at ST tax rates, not LT, though Treasuries are not taxable at the state level. You might be trading LT cap gain for future state-less ST cap gain?
alex_686
Posts: 13320
Joined: Mon Feb 09, 2015 1:39 pm

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by alex_686 »

Lecture wrote: Thu Aug 18, 2022 1:24 pm So my general question is really - do you routinely swap out Treasury bonds just to harvest losses, and is this really cost effective in the long run? Thanks.
It is a valid option. The math behind this is complex with multiple moving parts and requires some technical skill. Paying 1% would, hopefully, buy you that skill. It should also pay for the advisor to sit down and walk you through the math.

Note, you have suffered a loss on the Treasuries. That it is unrealized and that you will make up for it over time is immaterial. It is the type of mistake that Behavioral Economics talks about. A good advisor should help you avoid these. On the other hand you are shifting your asset allocation from long term bonds to short term bonds (i.e. cash). Why? Have your market expectations, risk profile, or goals changed? This part of the story makes no sense.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Topic Author
Lecture
Posts: 30
Joined: Wed Oct 27, 2021 8:10 am

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by Lecture »

alex_686 wrote: Thu Aug 18, 2022 1:57 pm
Lecture wrote: Thu Aug 18, 2022 1:24 pm So my general question is really - do you routinely swap out Treasury bonds just to harvest losses, and is this really cost effective in the long run? Thanks.
It is a valid option. The math behind this is complex with multiple moving parts and requires some technical skill. Paying 1% would, hopefully, buy you that skill. It should also pay for the advisor to sit down and walk you through the math.

Note, you have suffered a loss on the Treasuries. That it is unrealized and that you will make up for it over time is immaterial. It is the type of mistake that Behavioral Economics talks about. A good advisor should help you avoid these. On the other hand you are shifting your asset allocation from long term bonds to short term bonds (i.e. cash). Why? ....
Sorry, I wasn't clear; the cash raised in selling the long term low-interest rate Treasury would pay for new (& higher rate) Treasuries, with anywhere from 3 mos to 2 yr maturities. Right now the yield curves don't seem to indicate an advantage at more than 1-3 yr YTM, at least by my view.
Nice call on my Behavioral Economics mistake!
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by grabiner »

Lecture wrote: Thu Aug 18, 2022 1:24 pm For instance, I've got a Treasury bond maturing in 2030, YTM 1.5%. If I sell it now, I'll generate a $3900 loss; that's 11% of what I paid for the bond. Broker says buying 3 mos Treasury bills (currently 2.5%) will eventually make up that loss.
The 1.5% is not the YTM on the Treasury bonds; it is the coupon rate. The Yield To Maturity on this bond (maturing 2/15/30) is 2.973%; this is why the bonds are down 11% from its original price. (A bond which has a 7-year duration and has a yield 1.5% over par is at a discount of 10.5%.) Also, while you write "bond", you presumably have about 35 of them.

This particular trade is a poor strategy. Harvesting a loss may be a good idea, but you should not be changing from intermediate-term bonds to short-term bills unless your needs have changed. If you want to harvest the Treasury loss, it would make sense to sell the Treasury and buy some other intermediate-term bond, or a bond fund holding them.
Meanwhile, the loss can offset some equity capital gains.
And that is not the best way to use the loss. If you are in a 24% tax bracket, taking a $3000 capital loss in the same year that you have capital gains will save you $450, while taking the loss in a year that you have no capital gains will save you $720.

The other issue is that tax loss harvesting an individual bond is trading the current tax benefit for a future tax cost. If there were no wash-sale rule, you could sell these bonds and then buy them right back; you would have a $3900 capital loss, but $3900 more of interest in future years, taxed at your full tax rate. This is still a net benefit if the capital loss and interest are taxed at the same rate, as you postpone taxes. (And it is a bigger benefit if your state allows you to deduct capital losses on Treasury bonds; most states do.) But if the capital loss offsets a capital gain taxed at 15%, while the interest is taxed at 24%, the dollar loss is not worth the value of postponing the tax payment.

(Note that this issue is specific to individual bonds, not to funds. If you sell Bond Fund A for a capital loss to buy Bond Fund B which holds similar bonds, the two funds will have similar dividend distributions, so you get a clear net benefit.)
Wiki David Grabiner
Topic Author
Lecture
Posts: 30
Joined: Wed Oct 27, 2021 8:10 am

Re: Swapping Treasury bonds to generate capital loss to offset equity capital gain?

Post by Lecture »

Thank you for the thoughtful analysis, a lot to absorb there!
Post Reply