Impact of Biden’s Capital Gains Proposal on the Performance of Loss-Harvesting Strategies

Tax Regime Change
August 19, 2020

aperio tax economics

As part of a broader tax plan,1 US presidential candidate Joe Biden has proposed changes to the treatment of capital gains. Because Aperio manages portfolios designed to increase investors’ capital gains efficiency, we explored the impact of the proposed changes on the after-tax performance of loss-harvesting strategies.


Should the proposed changes come to pass, we would expect the following results, depending on how an investor in the top tax bracket disposes of a portfolio at the end of the holding period:

  • Investors who donate their securities to charity should expect higher after-tax returns.
  • Investors who liquidate their portfolios should expect lower after-tax returns, unless they can strategically realize capital losses in years when income exceeds $1 million and realize gains in lower-income years. These “Perfect Timing” investors should expect higher after-tax returns even with liquidation.
  • Investors planning to take advantage of the basis step-up upon an estate event will need to reconsider their circumstances.

Two Main Changes

In addition to considering the lack of clarity that typically characterizes tax proposals not yet enacted, it is important to note that official information has limited precision. Our analysis is based on the following proposed changes:

  1. Long-term capital gains for individuals in years when income exceeds $1 million would be taxed at ordinary income rates, which would increase to levels in place before enactment of the Tax Cuts and Jobs Act of 2017 (TCJA).
  2. The cost basis step-up at death would be eliminated.

The first change would increase the federal tax rate on long-term capital gains for investors with income over $1 million from 23.8% to 43.4%.2 This would materially impact the expected after-tax performance for most loss-harvesting investors.

For the second change, the proposed elimination of the current basis step-up is clear, but there is some uncertainty around whether unrealized capital gains would become taxable at death or if the cost basis would be carried forward to heirs.

Back-Testing Two Scenarios: Estate/Donation and Liquidation

At Aperio, we currently use two scenarios when presenting after-tax active return estimates: Estate/Donation and Liquidation. The first assumes no capital gains tax will be owed on unrealized gains at the end of the investment period, while the second assumes the loss-harvesting portfolio is moved to cash, which would realize all gains and losses and trigger capital gains taxes.

If unrealized gains become taxable at death, the Liquidation case would be interpreted to also include a portfolio that passes through an estate. What we refer to as the “Estate/Donation” case would just become the “Donation” scenario regardless of whether unrealized capital gains become taxable at death or the cost basis is carried forward.

If the cost basis would be carried forward instead, the donate/liquidate decision simply would move to the next generation; i.e., an estate event could no longer be used to mark the end of the investment horizon for measuring after-tax performance.

We used our After-Tax Back-Testing Analysis Tool to get a sense of the magnitude of the impact these changes might have had on historical after-tax performance. We ran an index-tracking strategy with the Russell 1000 Index as both the benchmark and the universe from which we purchased securities. By staggering the start date, we generated multiple runs of the strategy under two different tax regimes started January 31, 1987, and ended June 30, 2020, applying only top marginal federal capital gains taxes including the 3.8% Medicare surcharge (Net Investment Income Tax) in calculating after-tax active return. We then looked at the performance over the first five, 10, and 20 years of the strategy and averaged the results across those different back-tests.


The charts below show the average after-tax active return at various investment horizons for both Donation and Liquidation scenarios. Within the Liquidation scenario, we highlight a Perfect Timing option described below.

We observe: 1) an improvement in after-tax performance for investors who donate their portfolios because long-term losses would provide a greater tax benefit, 2) a reduction for those planning to liquidate when they pay the new higher rate to convert their portfolios to cash, and 3) an increase for investors who can benefit from losses applied against gains at the highest rate and then time the liquidation to be at the current long-term rate by actively managing their income.

Under the proposed rules, an investor who needs to liquidate some or all of a loss-harvesting portfolio (realizing long-term capital gains) should seek to do so in years when their income is less than $1 million whenever possible (in retirement, for example). By doing so, the realized long-term gains would be subject to the existing long-term capital gains rate (typically 23.8%) instead of the proposed higher rate (43.4%). As a simple proxy, this flexibility may be available to only some investors,3 and the benefits are obvious by comparing the Liquidation to the Perfect Timing scenario results, but further potential opportunities for tax management would likely be available if the actual tax regime were to move to something like this simplified proposal. 4


These results show that changes in the capital gains code can have substantial impacts on the expectations and processes of tax-efficient portfolio management. The obvious question is: should investors take any proactive steps now?

We don’t provide tax advice, and the potential impact varies too much per investor to offer broadly applicable guidance. However, as a general observation, tax proposals seldom become law in their original form. For a period before the passage of the TCJA in 2017, it looked very possible that FIFO (first-in, first-out) would be the required relief for capital gains, but by the time the final bill passed, it didn’t include that provision.

It would seem most appropriate to consider other parts of the potential Biden tax proposals rather than anything in direct relation to loss harvesting. For example, if an investor is concerned about an increase in long-term capital gains rates and has the flexibility to control the timing of gain realization, realizing those gains in 2020 instead of 2021 could be advantageous, depending on one’s assessment of the probability of various election outcomes.

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Contributing author: Taotai Cai, Aperio Quantitative Researcher.


1 Other parts of the plan, such as itemized deduction limits and phase outs, may impact the value of donation strategies related to our loss harvesting accounts, but we have kept the focus on loss harvesting strategies here.
2 The 43.4% consists of the new highest ordinary marginal tax bracket of 39.6% plus the 3.8% Net Investment Income Tax. This is compared to the current highest long-term capital gain tax rate of 20% plus the 3.8% Net Investment Income Tax.
3 Individual circumstances vary widely when it comes to income, but this option seems much more viable for those with less than $30 million in wealth rather than those with more than $100 million.
4 This timing effect also works the other way around. Adding cash to a loss-harvesting portfolio generally increases the opportunity to harvest losses. Strategically doing so in high-income years (when realized capital losses will be more valuable) would also be expected to improve after-tax performance. In the absence of any cash flow activity, we would expect strategies that deliberately seek to realize long-term gains in low-income years in order to create additional opportunities to realize losses in high-income years to have much broader appeal.

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