Accelerated Tax Loss Harvesting (Long/Short Portfolio)

A long-short equity portfolio generates more tax loss harvesting opportunities through the use of short positions.

This strategy is a special circumstance/branch of Tax Loss Harvesting, and assumes that you have already read that article.

Strategy Overview

As noted in Tax Loss Harvesting, recognized capital losses can be used to offset capital gains, dollar-for-dollar, for tax purposes. However, a commonly cited challenge of the strategy is that the losses generated from a traditional tax-loss-harvesting portfolio may take a while to occur, and/or may not be as large as individuals desire for their tax planning purposes. A way to accelerate the amount of losses a portfolio generates (while still maintaining approximately the same exposure as a traditional portfolio) is to use a long-short equity portfolio.

Tax Details

A long-short equity portfolio involves investing in both long and short positions, with the total portfolio calibrated to the desired "net exposure". For example, a portfolio that is 130% long and 30% short (130/30) will generate more losses due to both long and short positions, while its net exposure (100%) is identical to a traditional "long only" portfolio.

The benefit of the strategy is that portions of the portfolio should have losses in both up and down markets. For example, when markets rise, the short positions will generate losses while the long positions have gains. And conversely, when markets fall, the long positions create losses while the short positions create gains. All in, having both long and short stock positions creates more consistent opportunities to realize losses that can be harvested for tax purposes, but in most cases with the same total net exposure (100%) as a traditional "long only" portfolio.

There is no "free lunch" here however, and the benefits of the strategy need to be considered alongside the complexity and costs. Shorting stocks requires one to pay borrowing fees, and also typically requires incurring and paying "margin interest" on borrowed funds. And balancing (and rebalancing) the portfolios net exposure over time definitely increases complexity.

For more information, we recommend reading: Morningstar: Taking Tax-Loss Harvesting to the Next Level

Key Benefits

• Generates more tax loss harvesting opportunities compared to a long-only portfolio; in both up and down market environments. Having dedicated short positions in addition to long positions should enable you to generate taxable losses in all market conditions.

Key Considerations/Flags

• Frequently has higher costs to implement (borrowing costs for short positions; margin interest). The costs required to implement the strategy need to be considered alongside the targeted tax benefits.

• Necessitates thorough understanding of financial markets, short-selling, portfolio construction, and the associated risks involved. This strategy is typically not suitable for less sophisticated investors.

• Tax rules around loss deduction limits, wash sales, and capital gains rates still apply and can limit benefits. Consultation with a tax advisor is highly recommended.

Strategy: When to Consider This and When to Avoid It

🟢 When to Consider This Strategy:

• If you have a sizable, taxable investment portfolio and receive regular capital gain distributions or often realize gains

• You anticipate recognizing a large capital gain in the future and desire to tax-manage the position

• You have a strong understanding of markets, and the risk and complexity this strategy involves

🔴 When to Not Use This Strategy:

• You do not have, and do not anticipate having, realized capital gains

• You lack financial sophistication or access to guidance on implementing properly

• You wish to avoid leverage or shorting stocks for philosophical reasons

• The added complexity and costs of implementing this strategy do not provide enough benefit

Example