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Two Birds and One Stick: Tax-Efficient Hedging Against Rising Interest Rates  


Author:  Thomas Boczar.; Mark Leeds.


Source: Volume 31, Number 01, Fall 2017 , pp.5-14(10)




Journal of Taxation and Regulation of Financial Institutions

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Abstract: 

Although the Federal Reserve Bank has slowed its campaign to increase interest rates, up nonetheless seems to be the direction that rates are going. Increasing interest rates is never good news for a bond portfolio (interest rates move inversely to bond prices). As a result, banks, other financial institutions and other persons with large fixed-income portfolios may desire to hedge themselves against the loss in bond value that can occur in an increasing interest rate environment. And if the hedging strategy can free up suspended capital losses, all the better. For all U.S. taxpayers, capital losses can be deducted only against capital gains (plus $3,000 for non-corporate taxpayers). Accordingly, a hedging strategy that can generate capital gains may be extremely advantageous. The authors explore the ins and outs of short selling premium Treasury securities in a manner that has the potential to both protect a portfolio against the ravages of the market and utilize tax attributes.

Keywords: deductibility, capital loss, capital gain, economic substance, business purpose, C corporation, deferred tax asset

Affiliations:  1: Intelligent Edge Advisors; 2: Mayer Brown LLP.

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