The 10-year Treasury yield is hovering near 5%, triggering a sharp decline in bond prices. Investors holding bond mutual funds or bond ETFs now carry unrealized losses in their portfolios, which can be used to offset capital gains. With the stock market delivering double-digit returns this year, the value of bond tax-loss harvesting stands out prominently.
Financial advisors say there's no need to wait until year-end to sell; even if the Federal Reserve hikes rates again, yields still have room to rise, making year-end moves not necessarily the optimal tax strategy. Fund giants like Vanguard and American Century Investments have already alerted investors to this tax strategy—but the key is identifying individual fund positions with losses and carefully adhering to IRS wash-sale rules.
Where to begin
The bond sell-off has caused many investors pain, but it can also turn paper losses into a tax advantage. With the 10-year Treasury yield hovering near 5%, bond prices have fallen. Investors who bought bond funds or ETFs during lower-yield periods now have unrealized losses in their portfolios. Investors typically wait until December to execute tax-loss harvesting—selling investments at a loss to offset capital gains from other investments. But there's no need to wait until year-end. The high yields currently dragging down bond ETF performance may instead become a tax asset, while allowing you to reinvest at higher yield levels.
Joseph Gotelli and Jason Greenblatt, senior portfolio managers at American Century Investments, wrote in a recent article: "Tax-loss harvesting is often treated as a year-end task, but markets don't run on a calendar. In the current fixed-income market, there are solid opportunities to harvest losses, manage tax burdens, and simultaneously improve yield and tax efficiency."
With the bond market weakening over recent years, industry consensus increasingly recommends investors routinely evaluate tax-loss harvesting opportunities. In its fourth-quarter ETF industry report last year, Vanguard noted that as long as opportunities arise, regularly harvesting tax losses for client portfolios is a prudent approach. Vanguard pointed out that with bond prices falling and stocks at record highs, there is almost no loss to harvest on the equity side.
Here's what bond investors need to know to take advantage of the current bond market decline for tax-loss harvesting.
Popular targets for tax-loss harvesting
This downturn has created tax-loss opportunities for a broad swath of investors. For example, Vanguard Total Bond Market ETF (NYSEARCA: BND) and iShares Core U.S. Aggregate Bond ETF (NYSEARCA: AGG) have both fallen more than 3.5% year-to-date. Connor Kelley, partner and senior wealth advisor at Kansas-based Prime Capital Financial, said: "Strike while the iron is hot—these unrealized losses may not last forever. Don't wait until year-end; losses could narrow or even disappear."
Christine Larson, founder and wealth advisor at Minnesota-based NewSpring Wealth Partners, noted that with stocks delivering double-digit gains this year, bond tax-loss harvesting is especially relevant. For instance, the S&P 500 is up about 13% year-to-date. "In many clients' portfolios, bonds are the only asset class that's down."
Cost basis analysis is critical
Don't decide whether to sell based solely on the fund's current price. Bill Schwartz, managing director at Maryland-based Wealthspire, said: "A negative year-to-date price for an ETF doesn't automatically equate to a tax-deductible loss. For example, buying Vanguard Total Bond Market ETF on January 2nd without reinvesting dividends would currently produce a tax loss due to price decline; the ETF closed at $74.04 on January 2nd and was $71.40 on September 21st. But if you've accumulated shares over multiple years through several purchases, you may not necessarily have a tax loss."
Your cost basis is your purchase price plus brokerage commissions and various fees. Compare the current market value against the cost basis to determine whether selling results in a gain or loss. Reinvested dividends and interest continuously add to your share count, raising your overall cost basis—brokers typically track this for you. This is the core metric for screening suitable bond positions for tax-loss harvesting.
Mitch Schlesinger, chief investment strategist at Virginia-based Evermay Wealth Management, explains: The simplest approach is to liquidate the entire position; if you don't want to completely abandon similar exposure, you can swap into a different fund with different credit quality or a different underlying index, in which case you'd look at the fund's average total cost basis—the average of all purchase batches plus dividend reinvestments.
Fine-tuning loss lots within the same fund
Advisors prefer a more refined approach: splitting different purchase batches within the same fund to uncover harvesting opportunities. Even if the overall position is profitable, certain specific purchase lots may still be at a loss, allowing you to sell just those lots for tax deduction purposes. For example, an investor holding 100 shares of a bond ETF acquired in two separate purchases would have two independent tax lots. Even if the overall holding is profitable, one of those purchase batches could be in an unrealized loss position.
Larson said: "So you must look at the tax lot details, not just the overall gain or loss."
Schlesinger advises selecting sell lots based on purchase timing and dividend reinvestment patterns. An investor who bought an ETF in 2007 might have significant overall gains, but still needs to examine each purchase batch individually. Advisors can help with screening; without one, you can view each lot's cost basis in your online account, or contact your custodian to request detailed records if information is incomplete. Many online brokers offer tax-optimization settings that automatically select the best lots to maximize deductible losses, and investors can also manually choose which lots to sell.
Mind the IRS wash-sale rule
Be wary of the wash-sale rule when tax-loss harvesting: If you sell a security at a loss and buy a "substantially identical" security within 30 days before or after the sale—a combined 61-day window—the loss cannot be claimed for tax deduction. Schwartz of Wealthspire said tax-loss harvesting simultaneously involves an investment decision. If you're bullish on your original holding and can't find a sufficiently differentiated replacement, it may not be appropriate to sell; you could wait 31 days to buy back, but the opportunity cost of those 31 days is unknowable in advance.
Kelley believes the negative impact of a brief bond cash position is relatively smaller. Compared to equity tax-loss harvesting, small bond losses are easier to manage; holding cash for 30 days before repurchasing doesn't carry the same fear of missing a stock surge. "With fixed income, the pressure of sitting in cash for 30 days is far less than with stocks—you don't worry about missing a big rally after selling."
Don't try to time the market
U.S. Treasury yields may continue to rise, especially after the Fed's recent rate hike and signals of at least one more move this year. The latest hot economic data further pushed bond yields upward. Some investors want to delay loss harvesting, but precise timing is extremely difficult. Schlesinger said: "You can certainly wait—if rates keep climbing and bond prices fall further, you might harvest a larger loss in the future. But the loss you have today is certain; the potential future loss is uncertain. Completing tax-loss harvesting today doesn't mean this year's opportunities are over. If rates rise further later, other holdings or replacement positions may generate new unrealized losses, and you can continue harvesting. Tax-loss harvesting is a year-round opportunity to track, not a one-time trade requiring perfect timing."
He added: The Fed controls the short-term federal funds rate; longer-term Treasury yields are market-priced, reflecting inflation, economic growth, and market expectations for future rates—not fully determined by the Fed. "Even if the Fed signals more rate hikes, 5-year and 10-year Treasury yields may not rise. If markets believe that sustained hikes will eventually weigh on the economy and lower inflation, long-term yields could stay flat or even decline, bond prices would recover, and the current tax-loss opportunity could shrink or disappear."
"I wouldn't try to perfectly time the bottom in bond prices. As long as there's a meaningful unrealized loss today and you can maintain the client's required investment exposure after selling, you should seize the opportunity in front of you."
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