Selling a high-value asset often comes with a significant downside: paying a substantial portion of your proceeds to the IRS. Fortunately, there are strategies that can help you retain more of your hard-earned gains, even after tax season.
One particularly exciting approach is gaining traction: long/short tax-aware investing. Recently featured in a Bloomberg article, this strategy builds upon traditional tax-loss harvesting while addressing some of its inherent limitations.
Tax-Loss Harvesting Basics
Tax-loss harvesting is a widely used technique that allows you to sell positions at a loss to realize capital losses, which can offset capital gains. Since capital gains taxes are owed only on net capital gains (Capital Gains – Capital Losses = Net Capital Gains), this strategy can significantly reduce your tax liability. Any stock that is sold is immediately replaced by a similar stock to keep the portfolio fully invested.
However, there’s a catch: historically, stocks tend to increase in value over time, meaning opportunities to “harvest” losses may become scarce. When losses aren’t available, the effectiveness of tax-loss harvesting diminishes.
How Long/Short Tax-Aware Investing Works
This is where long/short tax-aware investing comes in. Rather than holding a standard portfolio of 100 stocks, this approach involves purchasing additional 50 desirable stocks while shorting 50 less desirable stocks. Shorting a stock allows an investor to make money when the stock price falls. The result? A net position equivalent to holding 100 stocks, but with a key advantage:
- Market Goes Up: Losses can be realized on the 50 short positions.
- Market Goes Down: Losses can be realized on the 50 long positions.
Meanwhile, the core portfolio—the initial 100 stocks—continues to focus on driving returns, typically aligned with a passive allocation to an index like the Russell 3000, which has averaged a 12.89% annual return over the past decade[1].
The Potential Benefits
Research supports the effectiveness of this strategy. A 2023 paper by Lieberman et al. found that long/short tax-aware portfolios “…if implemented with a sufficiently high level of leverage and tracking error, can realize a cumulative net capital loss of 100% of the invested capital within a few years and, at the same time, substantially outperform the benchmark index before tax, net of implementation costs.”[2]
For business owners, real estate investors, or those with highly appreciated stock portfolios, the benefits become clear. Not only can this strategy help mitigate current tax liabilities, but it also allows you to bank capital losses for future use, creating long-term flexibility in managing tax obligations.
Keeping More of What You’ve Earned
At Barrington Wealth Management, we’re excited about the evolution of advanced tax-loss harvesting strategies like this one. They offer a unique opportunity for business owners to preserve more of the value they’ve worked hard to create.
This is just one component of our holistic financial planning process, designed to help business owners and their families achieve their financial goals. If you’d like to explore this strategy further or learn more about our comprehensive approach, we’d love to start a conversation.
The views stated in this article are not necessarily the opinion of CWM, LLC. And should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility with the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market.
Investment minimums and restrictions apply. The minimum investment for AQR Flex 145/45 is $1 million which must be in a taxable portfolio with assets that can be margined (including cash and cash equivalents, stocks, ETFs, equity mutual funds). The minimum investment amount for AQR Flex 250/150 is $3 million which must be in a taxable portfolio with assets that can be margined (including cash and cash equivalents, stocks, ETFs, equity mutual funds). A separate portfolio margin agreement is required.
[1] Source: YCharts. Russell 3000 Index. Data from 11/30/2014 to 11/30/2024.
[2] Liberman, Joseph, et al. “Beyond direct indexing: Dynamic direct long-short investing.” The Journal of Beta Investment Strategies, vol. 14, no. 3, 8 Aug. 2023, pp. 10–41, https://doi.org/10.3905/jbis.2023.1.045.
