FYE 2012- A Golden Window of Opportunity to Harvest... Gains?

Posted by Investment Management Group on Jan 12, 2012 12:00:03 PM

As many portfolio managers are familiar with the concept of harvesting losses in an effort to be as tax efficient as possible, the idea of harvesting gains probably sounds strange. However, fiscal year 2012 may be a year where it is more tax efficient for regulated investment companies to harvest gains instead of losses. In December 2010, the Regulated Investment Company Modernization Act of 2010 (the “Act”) was passed into law to much fanfare from the industry. Most provisions of the Act are effective for fiscal years beginning after the date of enactment, which in most cases starts with fiscal years ending December 31, 2011 and beyond. One of the beneficial provisions of the Act was the elimination of the expiration of the carry-forward of losses realized in fiscal years beginning after the date of enactment. Pre-enactment losses remained subject to expiration. One tiny little detail of the Act that is not frequently discussed is that, although post-enactment losses are no longer subject to expiration, they must be utilized before a fund can utilize any pre-enactment losses, which are subject to expiration. Therefore, there is now a greater likelihood that pre-enactment losses will expire worthless, depriving the fund and its shareholders the benefits of tax loss harvesting prior to December 2010.

In order to derive the maximum benefit of pre-enactment loss carryforwards, portfolio managers should consider realizing gains to the extent of the pre-enactment loss carryforwards. One rule portfolio managers are often concerned with when it comes to harvesting losses is the wash sale loss rule. The wash sale loss rule disallows losses on the sale of a security to the extent a substantially similar security is purchased within a period beginning 30 days before the sale or disposition of the loss shares and 30 days after such date. Fortunately, there are no such rules with respect to sales that result in a gain. Therefore, a portfolio manager could potentially sell shares to realize a gain, and utilize a pre-enactment loss carryforward, and immediately repurchase the same shares to maintain the same portfolio composition. Of course, a cost/benefit analysis will need to performed on the transaction cost. However, fiscal years ending in 2012 may be a unique time where such a strategy will be beneficial to funds and their shareholders.

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