Most financial plans treat a primary residence as an asset that grows quietly in the background. For a growing number of clients, it is a taxable event waiting to happen.
Home values have risen sharply since Congress last set the capital-gains exclusion on primary residences in 1997. That exclusion has never been indexed to inflation. The result is a tax bill that a lot of homeowners, including the millionaire next door, never saw coming.
This is not a niche issue, and it is only expected to grow. It is also an opportunity for advisors who see it coming.
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The Taxpayer Relief Act of 1997 allowed an exclusion of $500K of capital gains for joint filers, or $250K for single filers, on the sale of a primary residence.
At the time, the median home price was $129K. Today it is over $440K.
The exclusion has never been adjusted for inflation. Politicians have floated raising the caps, expanding eligibility, and exempting sales entirely. None of it has passed.
Consider a couple in their 60s. They bought a home for $250K in 1980 and put $200K into it over the years, so their cost basis is $450K. They want to sell today in what has become a high-cost-of-living area, at a current value of $1.5M.
At a 20% tax rate, that is a $110K tax bill even after the exclusion.
PAGE 2 Illustrative example only. For full details, view the IRS guidance (irs.gov/taxtopics/tc701).
Nothing about that couple is exotic. They bought a house, stayed in it, and maintained it.
This is a widespread issue
PAGE 2 Sources: Redfin, National Association of Realtors, Yale Budget Lab.
The numbers are starker for seniors who have been in their homes for many years and have benefited the most from rapid home price appreciation. Research from the American Enterprise Institute identifies 1.9 million senior households with home-equity gains that already exceed their capital-gains exemption. In high-cost-of-living states, the count of households above the threshold runs higher still.
PAGE 2 The profile of a household already over the exclusion.
Look at that profile. Average net worth of $5.7M and average income of $431K. These are core client households at most advisory firms, not the ultra-high-net-worth tier.
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An astute advisor would consider the future tax implications as part of financial planning for all clients, not just their ultra-HNW clients. |
Tax-loss harvesting is the practice of selling securities that have declined in value to realize a capital loss. Those losses can offset long-term and short-term capital gains, including the gain from a home sale above the exclusion amount. Unused losses carry forward indefinitely, and up to $3,000 per year can offset ordinary income.
The US equity markets provide ample opportunity to harvest losses. Since 2000, an average of 41% of S&P 500 stocks have finished the year in a loss. Even in up markets there are losses to harvest, which means a client can steadily accumulate a reserve of losses well before they ever plan to sell a home. There are multiple strategies, long-only and long-short, that fit clients of different sizes and needs.
Harvesting is usually framed as a tool for offsetting equity gains, and usually reserved for the wealthiest clients. The capital gains tax on primary residences is a reminder that the use case is broader. Every client is happier paying less in taxes, and you will look wise for building this into the plan long before the bill comes due.
The objections, answered
Advisors have historically reserved tax-loss strategies for their wealthiest clients, since those clients tend to have the largest gains to offset. These strategies are complex, and it is fair to ask whether the complexity is worth the risk for a high-net-worth client.
It is. But implementation matters.
Losses accumulate over years, not weeks. A strategy started after a client decides to sell arrives too late to help.
That is the whole argument for raising this now, with clients who have no plans to move. The advisors who benefit the most are the ones who stay one step ahead.
As home prices rise and Baby Boomers move through retirement and downsizing decisions, more clients will face capital-gains bills on primary residences they never anticipated.
A proactive tax-loss harvesting strategy belongs in every financial plan. Not just the wealthiest clients, and not just the ones about to sell. Tax planning started early can meaningfully reduce that bill.
Burney's tax-aware long-short strategy (TALS) is one way to get there. It is easy to explain, it puts performance first, and it suits a wide range of clients rather than only the ultra-HNW.
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IMPORTANT DISCLOSURES
HYPOTHETICAL PERFORMANCE, IMPORTANT NOTICE
The analyses, charts, and portfolio projections contained in the White Paper are based entirely on hypothetical simulations and modeled outcomes. They do not represent the actual performance of any investment product, account, fund, or strategy managed by The Burney Company or any affiliated entity. No actual client assets were managed using this strategy during the periods depicted. Hypothetical or simulated performance results have certain inherent limitations. No representation is being made that any account will, or is likely to, achieve profits or losses similar to those shown.
130/30 DISCLOSURES
We execute this strategy at two custodian firms: Interactive Brokers and Schwab. Both custodians offer competitive margin rates vs other custodians. Clients seeking to utilize this strategy will need to sign a margin agreement with the custodian firm. The strategy can only be executed in taxable accounts with a minimum investment of $250k.
The primary risks associated with this strategy include the following:
The strategy is intended for sophisticated investors with aggressive or moderately aggressive risk tolerances who understand its complexity and the potential for unlimited losses associated with short selling. Past performance is not indicative of future results. All investments involve risk, including loss of principal.