tax alpha

Hi, need some help… Using the example in the schweser, says you start with 2 positions at a cost of 5000\$. One goes up 500 to 5500, and the other looses 500 to 4500. So the gain and losses ‘wash eachother out’ , and the book says you have a tax alpha of 75\$ (assume tax rate of 15%, so 500 * 15% = 75\$). My question is about the 75\$ gain. Is it like a non cash gain? because the way I see it, there is no actuall cash inflow, butmore importanatly no cash outflow… Is this correct? Thanks exciting friday night eh?

Do you have the pages in Schweser? This one stumps me. I don’t understand how the \$75 is considered a gain. In order to realize your profit on the stock that appreciated, you would have to sell it and pay capital gains. You could sell your other position at a loss, so the gain & loss would offset and you would owe no tax liability, but in no way would you end up with an extra \$75 in your pocket.

bk 2, pg 84, tax loss harvesting

This reading makes no sense to me. So what if you don’t have to pay taxes on your \$500 gain - you just lost \$500 on your other investment! You are in exactly the same position as when you began with \$5000.

thats what Im saying. Only thing that kinda makes sense is the non cash outflow of 75\$,and they figure this is some sort of gain…cfai books dont explain it to well either…

If you ignore the fact that you just lost \$500 on your depreciated stock, then you can consider the \$500 loss a tax shield… I think this is all Schweser is doing with their calculation.

well basically the loss is there anyways. just because it’s not realized it doesn’t really matter. all they are saying rather than paying tax and having a losing position, you can offset the two. that does not imply that you can not go back into your original position after the required period then that 75\$ you can reinvest an you create more value

Here is my take: Jan 1 2009 Buy \$5000 large cap fund 1 Buy \$5000 small cap fund 1 December 31 Sell \$5500 large cap fund 1 Sell \$4500 small cap fund 1 Buy 4500 small cap fund 2 \*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\*\* Scenario 1 Suppose you wanted to sell the large cap fund on Dec 31 because you thought it was overvalued at that point. You have the option of holding on to small cap fund 1. If you do so you have to realize a short term capital gain of 500. Net worth at the end of 2009 = 5500+4500 - taxes Scenario 2 (shown above) Suppose you wanted to sell the large cap fund on Dec 31 because you thought it was overvalued at that point. You could sell small cap fund 1 and immediately buy small cap fund two (this fund might have an R^2 with small cap fund of .98). By doing so we realize a capital loss of 500 which directly offsets our capital gain AND we are still invested in the small cap asset class to the tune of 4500 (same amount if we didn't sell in scenario 1). Net worth at end of 2009 = 5500+4500 You can see that in scenario 2 wins. By realizing the loss on small cap fund 1 in the same tax period (2009) as the gain we keep the taxes in the account. It is not an actual cash flow, but you don't have to pay the taxes out of the account. So the 75 gain schweser talks about is the amount of taxes you DON’T have to pay out due to offsetting the gain in the same period. Edit: my post crossed with pop’s

ilvino Wrote: ------------------------------------------------------- > This reading makes no sense to me. So what if you > don’t have to pay taxes on your \$500 gain - you > just lost \$500 on your other investment! You are > in exactly the same position as when you began > with \$5000. You have to look at the 500 loss on the stock as a sunk cost. You can’t change that now, but it has tax value.

you paid lower taxes. therefore, it’s a tax alpha. that’s the level of analysis i took from schweser.

thanks for clearing that up guys. I guess I’m just a loss averse investor and can’t get over the fact that I lost \$500 on the first fund

This “tax alpha” is a way for account managers to explain their clients that “it’s not so bad to have losses”… I reality this a just a *big joke* Having “no tax alpha” i.e. no loss is *always* better. In a way, clients should be happy to pay tax… MH

mhannebert Wrote: ------------------------------------------------------- > This “tax alpha” is a way for account managers to > explain their clients that “it’s not so bad to > have losses”… > I reality this a just a *big joke* > > Having “no tax alpha” i.e. no loss is *always* > better. In a way, clients should be happy to pay > tax… > > MH This is very true. I’m amazed at the way managers try to sell clients that the losses are a good thing. You would think that they are adding serious value by harvesting them.

yes that is true but is not the disscution here the disscution here is that once you have the loss how can you use it to reduce your loss. and the reality is that you can do tax planning

Assume you pay capital tax by liquidating your portfolio, and by realizing the tax loss, you do not have to sell stocks to pay taxes => tax alpha?

More likely On December 1st you sold security 1 at a capital gain of 110k On December 30th you have security 2 that has a capital loss of 100k. You sell it to offset the capital gain in security 1. Your tax alpha is the amount of capital gains you DON’T have to pay 100*tax rate

mhannebert Wrote: ------------------------------------------------------- > This “tax alpha” is a way for account managers to > explain their clients that “it’s not so bad to > have losses”… > I reality this a just a *big joke* > > Having “no tax alpha” i.e. no loss is *always* > better. In a way, clients should be happy to pay > tax… > > MH Awesome. Please provide your contact info ASAP so I can send money. I have very few accounts where every position always has unrealized gains and I am excited to benefit from this new guaranteed-no downside investment strategy you have uncovered.

slouiscar, I’m not saying that having loss is easy. I’m saying that “tax alpha” is a big word which could mean for some people that you are generating value when having losses and you are not. I’m sure you got the message.

This is how I think about it Scenario 1) Sold the 5500 , hold the 4500 ----> So I have 5500 - 75 ( tax on the 500 gain) + 4500 ( I did not sell) ----> Total value of my portfolio 9925 Scenario 2) I sold both —> Total value 5500 + 4500 = 10,000 Now I have a \$ 75 tax alpha

amit_cfa2 Wrote: ------------------------------------------------------- > This is how I think about it > > Scenario 1) > Sold the 5500 , hold the 4500 ----> So I have 5500 > - 75 ( tax on the 500 gain) + 4500 ( I did not > sell) ----> Total value of my portfolio 9925 > > Scenario 2) > I sold both —> Total value 5500 + 4500 = > 10,000 > > > Now I have a \$ 75 tax alpha Excellent explanation!