Investors can acquire algorithmically-controlled portfolios of hundreds of stocks that are built to track a broad stock market index but are also programmed to sell lossmaking shares throughout the year to crystallize tax losses and replace them with alternative investments to keep the portfolio on track.
Marketing materials from the investment manager Northern Trust Corp. demonstrate how sophisticated the products have become. It says the tax losses can be dialled up or down depending on how much deviation from the underlying index an investor is willing to risk. NT did not respond to a request for comment.
The Internal Revenue Service hasn’t provided much in the way of guidance about what “substantially identical” means in modern markets, with the result that different advisors take more or less conservative positions. Tax authorities could also squeeze investors in a variety of other ways that raise the costs or risks of the strategy – by making investment advisors liable for the violations of their clients, or just by subjecting more users of tax-loss harvesting strategies to gruelling audits. The IRS has just had US$80-billion added to its budget and is itching to spend it.