Mark's weekly blogging

Swapping to Lower Your Taxes

Tax swapping is the most common of all swaps. Anyone who owns bonds that are selling below their amortized purchase price and who has capital gains or other income that could be partially, or fully, offset by a tax loss can benefit from tax swapping.

You may have realized capital gains from the sale of a profitable capital asset (e.g., real estate, your business, stocks or other securities). Or you may expect to sell such an asset at a potential profit in the near future. By swapping those assets that are currently trading below the purchase price (due to a rise in interest rates, deteriorating credit situation, etc.) you can reduce or eliminate the capital gains you would otherwise have paid on your other profitable transactions in the current tax year.

The traditional tax swap involves two steps: (1) selling a bond that is worth less than you paid for it and (2) simultaneously purchasing a bond with similar, but not identical, characteristics. For example, assume you own a $50,000, 20-year, triple-A-rated municipal bond with a 5.00% coupon that you purchased five years ago at par. If interest rates increase (such that new bonds are now being issued with a 5.50% coupon), the value of your bond will fall to approximately $47,500. If you sell the bond, you will realize a $2,500 capital loss, which you can use to offset any capital gains you have realized. If you have no capital gains, you can use the capital loss to offset ordinary income. You then purchase in the secondary market a replacement triple-A-rated 5.00% municipal bond (from a different issuer), maturing in 15 years, at an approximate cost of $47,500. Your yield, maturity and quality of bond will be the same as before, plus you will have realized a loss that will save you money on taxes in the year of the bond sale. Of course, if you hold the new bond to maturity, you will realize a $2,500 gain in 15 years, taxable as ordinary income at that time. By swapping, you have converted a “paper” loss into a real loss that can be used to offset taxable gain.

 "Nobody realizes that some people expend tremendous energy merely to be normal." - Albert Camus

Financing is absolutely an art form and not a science. On the commercial side of doing a loan there are many intricate details that need to be wound together in a clear concise story for the underwriter; Depending on the type of funding the same details may tell many different stories.