Wealthy investors are pouring billions into this new tax strategy despite risks
Wealthy investors are pouring billions into a new tax-saving strategy despite potential risks, according to investment experts. Total assets invested in so-called tax-aware long-short strategies — or TALS — have surged to more than $170 billion from $2 billion in 2022, according to Tax Alpha Insider. The strategies seek to track equity indexes while generating tax losses that can offset capital gains taxes. TALS products and their variants have caught fire among wealthy investors. After three years of double-digit increases in the stock market, high-net-worth investors are sitting on large gains they don't want taxed. Business owners who have sold a company and executives who hold concentrated stock positions also are flocking to the products. The surge in IPOs, with many employees holding stock that soars in value, is adding to demand for products that can offset big realized gains. For the wealth management industry, tax-aware products have become a bonanza. As other investment strategies become commoditized or automated, complex long-short strategies command hefty fees and attract new clients. "These are phenomenally profitable and sticky products that the wealth management industry is incentivized to sell," said Bob Casey, CEO of Santa Barbara Management, which advises family offices. "They are growing at eye-popping rates." The tax benefits can be substantial. Casey gives the example of a portfolio with a $1 million investment. With a tax-aware long-short strategy, the portfolio could generate capital losses of $250,000 in the first year, though that would decline over time. For a California-based investor, the $250,000 in losses could be worth up to $137,500 if they're offsetting short-term capital gains, he said. Those tax benefits, however, come with risks. Tax attorneys and investment experts say too many wealthy investors are rushing into TALS strategies without fully understanding the details or investment implications. The surge in assets is also attracting scrutiny from tax authorities. Here are four main risks wealthy investors should understand before investing in tax-aware long-short strategies. Earlier this summer, Treasury officials speaking at a Wall Street Tax Association seminar warned of "aggressive planning" involving investment products that offer tax losses. They didn't name tax-aware long-short strategies specifically. But they cited similar so-called "tax-alpha" products, like 351 conversions, box-spread ETFs and other funds that generate losses. "We're not going to let sophisticated abusive tax structuring become a runaway train," one Treasury official said at the seminar, according to two people who attended. The officials didn't say the practices are illegal. For now, they're seeking more information and input from Wall Street and tax attorneys. Tax lawyers add that the Trump administration touts its light touch with financial regulation, so any changes will likely be well-telegraphed. "Treasury seemed to be suggesting that they would be taking a look at a lot of different products and they're going to use the different tools at their disposal," said Mohsen Ghazi, partner at Ashurst Perkins Coie.