In this conversation on “TAX ALPHA”, Frazer Rice and BRENT SULLIVAN (of TAX ALPHA INSIDER) delve into the complexities of tax awareness in investing, focusing on capital gains, income tax, and various strategies for tax efficiency. They discuss the importance of tax loss harvesting, the challenges of managing concentrated portfolios, and the implications of estate planning. The conversation emphasizes the need for advisors and trustees to understand these strategies to optimize tax outcomes for their clients.

https://youtu.be/pCIXFq4YoS0

Outline of Tax Alpha

Quick Overview of Tax Rates

Ordinary vs Capital Gain (Usually Income vs Asset based taxation)
Short Term vs Long Term (Long Term Treatment)
(we’ll talk about Estate Later)
Federal vs State (Can be important!)
Netting Losses/Deductions vs Gains and Income
Owning assets Taxable vs Non-Taxable vehicles

https://open.spotify.com/episode/3uL924aOlPd2hgmC9s7KCI?si=hBS09OKDTd-uHhT8PAj7aA

Tax Alpha in stock investing (Universe)

Long Only
- Concentrated Positions
  - Timing – Getting LT Capital Gain treatment
  - Basis – increasing basis
    - Exchange / 351 Funds to defer and diversify
    - Dramatic foreshadowing with step-up later in estate context
    - Blind Trusts for political appointees
- Diversified Positions
  - Passive (Lower Cost, acceptable returns, “lower risk/tracking error”)
  - Active (Now frowned upon – except in the after tax world w/ TLH)
- Deferral Carve-Outs like QOZ’s
Tax Lost Harvesting
- Owning an index vs owning a sample of the index
- Buying Coke and selling pepsi
- Wash Rules
- Loss Carry Forwards
- Capital Losses / Not Ordiany Losses
Amplified Tax Loss Harvesting
- Own the sample of Index AND
- Borrow off those holdings to create long and short positions to generate capital losses while having beta of 1

Trends:

Pre-Liquidity Event planning
- Storing Losses for the bulky sale
- Timing the event(s) to have the losses line up with the gains
Pre-Diversification planning
Pre Death Planning
- Integrating the Estate Planning with the Income/ Cap Gains Planning
  - Step-Up
  - Avoiding Estate Tax, But Prolonging the Cap Gains Tax exposure (and concentration risk?)
  - Grantor Tax status and he swap power
  - How does turbo charged loss creation look in an estate environment?
  - Trustee/ Executor and Fiduciary / Beneficiary risk issues
Vehicle evolution
- Funds
- SMA’s
- 351 and other ETF vehicles (+/-‘s)
- PPLI,PPVA

How did you develop this expertise?

How do we find you?

Transcript of Tax Alpha

Frazer Rice (00:01.122)
Welcome aboard, Brent.

Brent Sullivan (00:03.035)
Well, happy to be here, Fraser.

Frazer Rice (00:04.558)
It’s fun to chat in person. I’ve been following it to call a blog I don’t think gives it the proper respect because I think you’re uncovering a lot of great information for advisors like me and wealthy people and other people generally speaking in terms of Really getting going on the tax alpha end of it Let’s start a little bit with some basics because I think you know for someone new to the concept of Being particularly tax aware in terms of investing taxes can be, they’re more than just income tax, that’s for sure. How do you think about it? How do you get your framework around what people are trying to avoid when they’re dealing with their investable portfolios?

Brent Sullivan (00:45.723)
Yeah, I mean, there are really just a couple of different ways to break it down, but I probably start with the concept of a capital gain as a distinct thing from income tax. so capital gains come in really like four different flavors.

There’s short-term capital gains, short-term capital losses, and then long-term capital gains, long-term capital losses. And then these things are different if you have collectibles or other types of instruments too. But the point is here that you’ve got those four quadrants that you’re always sort of operating in.

And I think that’s where the management and the prowess around portfolio design, execution, that’s where all of that really comes into play. And the final point I’d make about capital gains versus income is that capital gains is really a planning opportunity. Income is gonna come at you and there’s really not much you can do about it. Strong caveat to that. But capital gains are really about timing. You can accelerate losses, you can defer gains.

Frazer Rice (01:37.929)
Right.

Brent Sullivan (01:45.079)
And that’s really the beginning of the conversation when I’m talking with advisors about this usually. I operate in B2B space, I’m not retail facing. And usually that’s where the planning conversation starts.

Frazer Rice (01:57.655)
So as you sort of step back and help people think about the tax planning aspect of it, for advisors generally speaking, they’re very interested not only in the investment perspective, but the structuring of wealth such that they’re taking advantage of what they can and mitigating that which is destructive, but otherwise not really something they can avoid.

If we settle in a little bit on the investment piece a little bit, what is the universe that we’re looking in in terms of how people allocate their portfolios?

Brent Sullivan (02:33.22)
Well, mean, so probably I’d say the hot topic in tax management nowadays is really getting the portfolio to be more equity like. And so the reason or part of the motivation for more equity like exposure is to utilize to the extent possible the planning opportunity of capital gains, realization and acceleration and things like that. So that’s that’s probably the core concept. The biggest chunk of the investable portfolio. The idea is to make it more equity like.

And then the planning opportunities sort of expand beyond the core portfolio. That’s in, you know, how can we align total diversified exposure across the right types of investment accounts? In your space, it starts to get really interesting.

You know, I say your space, like in a state planning world, it starts to get, you know, the idea of asset location, putting the stocks, you know, in the high growth portfolios or tax exempt portfolios, depending on the profile.

Frazer Rice (03:17.228)
Sure.

Brent Sullivan (03:26.458)
Putting the bonds in tax advantaged accounts or tax exempt accounts, again, depending on the profile. All of that is like, these are like really crisp, interesting planning questions that do not have crisp answers. And I think that’s where the planning opportunity really emerges.

Frazer Rice (03:42.668)
We talk a little bit about asset location. The investment vehicles we’ll talk about shortly and some of the things that can happen to turn the dials on that front. But in terms of location in whether ERISA accounts or life insurance or trusts or things like that, as people are trying to get their arms around the matrix, as you called it, and certainly with the capital gains and short and long, there’s almost a matrix of different things you can think about in terms of the tools in your toolkit. How do you get your arms around that if you’re new to the space or otherwise trying to really provide subtle advice as opposed to maybe speculative advice?

Brent Sullivan (04:23.214)
Yeah, I mean, I think that the first step is really trying to understand how each investment decision impacts not just the current investment returns, but also future investment returns, after-tax returns, pre-liquidation, post-liquidation, but then also estate considerations, like are you choosing the right vehicle if you’re trying to isolate or exclude assets from the estate? Do you want to keep a strategy on for multi-generations? Is it private? Public? Is it liquid? Iliquid?

Inflation protected? All this kind of stuff. You have to realize that every single investment decision involves or impacts this really complex ecosystem. It’s super interesting, but I think like first order decision is like how much of a thing should I own? That is just like the tip of the iceberg. And I would say that’s where 99 % of like the financial media focuses. You how should I invest a million dollars now? It’s like, no, boy. Like there’s so much more ground to cover that could make portfolios resilient today, but also with multi-generation in mind.

Frazer Rice (05:29.835)
As I like to say, trying to get past the two dimensions that most people are normally thinking about in terms of the X and Y of income and capital gains and then sort of layering on asset allocation to be responsible on that front, but then add the Z axis of the estate planning, really kind of years 10, 15, 20, and then going beyond your use of the assets to different constituencies that are going to benefit from it later.

Brent Sullivan (05:55.365)
I mean, I get so excited when I think about the opportunities in this space because they’re so messy and bespoke. And I say messy in a good way. These are real problems that planners have an opportunity to step in and address for high net worth folks. really, down market, I don’t say down market in a pejorative sense, but mean, in down market too, there are really opportunities for planners to step in and add meaningful value and like again, I am an observer of this industry.

I’m an independent tax analyst, which means that I don’t have a stake in the game. I don’t, I’m not trying to sell anyone’s product. So I just get to see the opportunities that planners have when they’re engaging with, with clients at all wealth levels. And again, like to your point, yeah, multi-generation is super exciting. It’s so messy and interesting.

Frazer Rice (06:43.755)
As we look at it here, the one unifying theme is most people don’t want to pay taxes if they don’t have to. success really does come down to what do you get to keep at the end of the day from the fruits of your labor or your investment. Without that unifying principle, then we’re sort of grasping at straws I guess.

Let’s start with the simplest sort of tools that we have in the toolbox. And this is gonna combine a little bit of investment vehicle and tax awareness in the long only space? What are the things that you’re thinking about in terms of the tools that a lot of people have access to, but maybe not have the tax awareness that we think is a good idea to think about?

Brent Sullivan (07:27.332)
Well, mean, the easiest thing or probably the highest level thing is just asset allocation specifically. And so that’s just like at the very, very simplest level that would be, you know, how much of your portfolio is allocated to growth assets like stocks versus how much of your portfolio is allocated to fixed income assets or something fixed income like like bonds.

That’s the first decision you need to make. It already has tax implications attached to it. And the first tax implication is are we dealing with the character of capital gains in the equity sleeve and we’re dealing with income in the fixed income sleeve. Okay, you already have like made tax decisions at that point.

So should you be augmenting portfolio allocation to make sure that your after-tax results are more favorable? Now again, to my earlier point, this is where more equity-like exposure starts to come into the fold. We haven’t even layered in any complex products or anything yet.

We’re still just talking about stocks and bonds. But then if we’re expanding beyond those core allocation decisions away from stocks and bonds and we’re adding different types of accounts. Again, like you said earlier, ERISA, other qualified accounts, IRAs, whatever it might be. Now we have an extra lever to pull.

Okay, great, maybe we should be putting all those bonds in the advantaged accounts such that we’re not realizing income or such that we’re not paying income tax and experiencing tax drag like on an annual basis. So that we can expand even beyond that and we can start thinking about planning around accelerating losses and deferring capital gains.

If we start matching those income or we start matching those assets, tax assets, probably through something like tax loss harvesting as a trick, and we’re matching that with capital gains liabilities that we’re expecting either through routine portfolio management or through an exit, we can start matching these things and really pushing out tax into further and further years.

And that’s really the planning opportunity there. And again, there’s plenty more we can do beyond that. But I think the basic tools, again, allocation and then location. And then if you want to get into the portfolio itself, there are specific products that might be able to dial in those concepts even a level further. I’m talking about things like no dividend ETFs to the extent that’s relevant and attractive to the investor.

Brent Sullivan (09:47.567)
And then there are other things now, interesting happening in fixed income. Okay, are there ways to defer the income such that, and to have it have a capital gains treatment instead of ordinary income? That’s probably, you know, those three tiers again, allocation, location, and then investment selection in the portfolios themselves, very powerful right off the bat. And again, we haven’t even done anything complex yet.

Frazer Rice (10:08.115)
So let’s dive into the complex. Tax loss harvesting, is really kind of the bell of the ball right now in the investment community and getting talked about on many fronts. Talk a little bit about the concept there of what it is to generate losses while maintaining the character of an investment profile that you think is appropriate for a client.

Brent Sullivan (10:28.91)
Well, OK, so let’s say that we’ve got a portfolio that’s 80-20 stocks and bonds. Let’s set aside the bonds for now. Let’s just focus on the stocks. So the stocks have capital gains treatment as an investment asset class.

And what that means is that as the portfolio is oscillating around its cost basis, right? So you buy the portfolio, you buy an asset for $100, and it appreciates above the $100 to $110. You’re in capital gains territory, unrealized capital gains.

If it trends below the cost basis, you’re in capital loss territory. And so the portfolio is bouncing around that critical number, the cost basis. If it’s below the cost basis, you have the opportunity to liquidate that asset, capture that tax loss, and then reinvest in something that is not exactly the same, but is similar in risk profile. Similar is the key word, not substantially identical.

And the idea is that you’ve captured this tax asset sits on your household balance sheet and it can be unlocked and utilized when you realize capital gains somewhere else, again, in the entire household portfolio, as long as it’s still within the estate.

That’s really the strategy there is to capture those tax losses and then to use them to offset gains that might be occurring elsewhere in the portfolio just through routine portfolio management, but it also might be through tax inefficient vehicles like managed futures.

It could be from some income program, again, capital in nature, not income. And those are really the opportunities that are immediately present through tax loss harvesting.

Frazer Rice (12:06.92)
One of the things I think is important is that typically most people say, oh, if you’re taking losses, is my portfolio going down? The reason why this is appealing is that, you know, instead of having one index that represents a particular, say the SP 500, you’re investing generally in a basket of stocks that is Sam is a sampling of the S and P 500, which allows you to take advantage of the oscillation while maintaining the investment characteristics of the larger S and P 500 index.

Did I square that correctly?

Brent Sullivan (12:38.224)
Yeah, 100%. Yeah, that’s it. I mean, so you’ve got S &P 500 exposure or Russell 1000, Russell 3000 exposure. And then what you’re referring to is really the granularity of individual holdings. And so you can imagine, if I hold one ETF and it’s oscillating around the cost basis, well, that these oscillations occur with much more violence and interest if the portfolio holds individual positions. The idea is that as those individual positions dip below cost basis, you sell them.

You reinvest in something not substantially identical but economically similar such that you maintain the same exposure. So you’re still getting the benefit of appreciation in the portfolio and the same risk reward characteristics. But now you’ve got these tax assets sitting on your household balance sheet.

Frazer Rice (13:26.123)
Now, one thing that’s sort of popped up as a product enhancement in this type of scenario is the idea of embedding short and long term overlays on top of this tax loss harvesting so that you can get the notional value beyond what’s being invested and generate more losses in addition to having your exposure to the underlying investment. Maybe talk about that a little bit for the listeners.

Brent Sullivan (13:55.995)
Yeah, I would say probably the white hot topic in core portfolio management nowadays is exactly what you said, Frazier. It’s adding additional margin or it’s adding a margin to the portfolio and then complementing that margin with short positions. Just to give it like a simple example, suppose that we have simplest possible example is probably imagine you have an S &P 500 ETF. Okay. Start with that as your core allocation and then you borrow against that

ETF, you use that ETF as margin and you add more long exposure. And so the long exposure, let’s assume that it adds another 100 % to the portfolio. So you started with $100, now your portfolio is $200 gross. And then you complement that extra margin long with shorts, and you do them the same as the margin.

You have $100 core portfolio, $100 margin extension, $100 short exposure and the idea is that the long Margin and the shorts are market neutral such that the manager who’s handling this is really interested in relative value between the two So your gross exposure in that case would be 100 margin 100 core 100 short for 300 gross exposure But your net exposure is just that 100 and the again those those extensions are market neutral ideally such that we’re capturing relative value.

That’s the pre-tax alpha argument. And then there’s a post-tax alpha argument where it’s like, there’s a lot of interesting opportunities to accelerate capital loss realization in the longs the shorts, depending on how violent the market is that you’re.

Frazer Rice (15:41.069)
That it’s one of the things that for the mad scientists among us, you can turn the dials and if you want something different than market neutral, i.e. you’re willing to take a little bit more risk on that front in the theory that you’re able to maybe generate some more alpha by in a sense just being a little bit more aggressive on the risk side of the investment.

Then you’re able to dial in a little bit more return while going for it on the tax loss generation end of things as well. We’re seeing that with different clients here. where the market neutral is very interesting and as part of a core allocation, a good idea.

Then they’re willing to listen to the manager underneath and say, might be an area where your prowess might be rewarded in a way that helps us on a pre-tax and a post-tax scenario.

Brent Sullivan (16:33.628)
Yeah, 100%. Yeah, I mean, so that’s probably the first order concern is always like, hey, does this investment make sense? Does it add, you know, maybe additional diversification principles, maybe, you know, whatever it might be, maybe pre-tax alpha generation. Like, that’s the first order concern.

Does this make sense? And then once you’ve broken through or confirm that barrier, because you’re going to expose the portfolio to additional tracking error, that is to say difference between the portfolio performance and the underlying benchmark, these extensions have risk attached to them.

If you’ve confirmed that it’s worth taking that additional risk and paying financing costs and whatnot, and all that is not free, then if all that makes sense, then finally you can say, actually there’s a lot of really great post-tax opportunities here too. And this really comes, let me just give you a quick flavor of it because it’s interesting.

On the long side, this is just as if you had injected a bunch of cash into the portfolio. And so from my earlier example

That’s just like you had reset the cost basis high again. So what that means is that the portfolio is pretty close to cost basis. Again, it’s oscillating around that really critical number. If the long extension dips below the cost basis, you can harvest those losses. That’s interesting, maybe even intuitive to some folks out there who are used to sort of direct indexing, typical tax loss harvesting. But on the short side, it’s really much more interesting.

Essentially, your shorts are a bet against the market. Okay, so if the market keeps going up, there’s almost always, nearly always, I don’t wanna say it’s not unlimited, it’s not in perpetuity, but almost always, there’s an opportunity to capture losses on the short side.

So this one’s quite simple to understand, it’s technically complex, but the idea is if the market’s going up, you have losses. Now that’s totally different than a long only mandate where if the market’s going up long enough, you sort of run out of losses, you run out of basis to mine.

If you think about it as like a little gold pile that you’re working into to try to extract tax assets, that disappears over time. Long short extensions reinvigorate that possibility, I don’t know, say almost in perpetuity, almost, heavy asterisk there.

Frazer Rice (18:44.068)
That’s right. No guarantees or anything like that. The asterisk is in bold and underlined. So we’ve been talking a little bit about really in a sense diversified portfolios and allocating in that world. If we get into the concentrated portfolios, many people build wealth.

They work at Google. People sell a business. They do something like that and they have or they have a business that haven’t sold it yet, but their wealth is concentrated in one thing or the other.

What is the universe around that to help sort of a tax-efficient component of either disposition or otherwise planning so that capital gains tax is as low as possible and it can get to the next generation or elsewhere in a more efficient way.

Brent Sullivan (19:28.634)
Well, let’s start with the long short as a solution in that specific case, because this is a very popular topic. It’s also, advisors are very interested in it because I think, because they’re getting inbound from clients who are just like, hey, I’ve got this really gnarly situation.

I’m holding, like you said, too much Google or I’m about to exit. So what can we do here? And I think this is really where the planning opportunity steps in. So if we assume.

Frazer Rice (19:35.299)
Mm-hmm.

Brent Sullivan (19:55.397)
Let’s assume that the investor is holding a publicly traded large cap stock just for simplicity. Let’s assume that we’re going to consider long short extensions around that concentrated position as a means to diversify, to de-risk over time.

The way that that works is the investor would contribute, let’s say their Google shares into a portfolio margin account. And the portfolio margin account just essentially uses risk-based criteria to be able to dial up the leverage pretty aggressively on the margin and short sides.

So the investor contributes the Google to a portfolio margin account and then uses, the manager uses the Google as collateral to again add that margin position on top and then shorts a complimentary portfolio to maintain that market neutral exposure.

Okay, so you’re getting that pre-tax alpha that is helpful for, know, always pre-tax alpha never hurts. But what’s actually happening is that, or what’s really happening in compliment to the pre-tax alpha is that you’ve got a lot of loss realization.

As you’re realizing capital losses, you are using those capital losses to offset capital gains as you wind down the concentrated position. Depending on the amount of leverage that you’re using in this portfolio, you can really exit the position tax neutral. That would be the objective. This is again, deferral, not avoidance. It’s deferral. You’re eventually pay the tax. Another strong asterisk!

The idea is that you want to try to execute this position tax neutral and you can do so if you’ve not already realized the gains that the typical timeline with a heavily leveraged portfolio, something like two years to exit tax neutral from that concentrated position. And if you’re uncomfortable with really, really high amounts of leverage, then you can do it something like in five years.

Frazer Rice (21:45.115)
I mean for people who are thinking long term, two to five years is much more palatable than say the standard where you have this big bulky position and you’ve got, let’s say you came in at 200,000 and it’s worth a million, and you’re saying, gosh, how do I get from here to there? That’s a meaningful sort of absorption of time to get you into a diversified place.

Brent Sullivan (22:09.562)
So that is really the critical point that you’re making. Like what is a graceful way to get from A to B? So it’s like, do you know what you want? Do you know what B is? What’s your ideal state that you want to gracefully transition into?

So if your initial state is concentrated stock and you’re like, wow, my ideal state is Russell 1000 diversification. I still want to upside exposure, but I just want to not be so idiosyncratically concentrated. Okay, cool.

Frazer Rice (22:23.81)
Mm-hmm.

Brent Sullivan (22:38.128)
What’s the most graceful way to get from A to B? And there are a bunch of different methods. Long, short, just a direct extension over a concentrated position will allow you to gracefully transition from A to B.

Now, there are other tools too in the concentrated toolkit. Probably the simplest is, of course, just to sell it. You could just exit the position instantly. Now, is obvious ramifications, tax ramifications.

Frazer Rice (23:03.788)
Simple, graceful.

Brent Sullivan (23:05.264)
Not graceful, know, yeah, yeah, it’s like yeah, it gets yeah, it gets gnarly now that makes sense for some folks though You know just be done with it, you know, let’s transition. Let’s diversify instantly.

You know, there are other tools there to like an exchange fund depends on the capacity the fun depends on the underlying characteristics of the name but probably for your audience I think it’s worth having the variable prepaid forward on their radar and so variable prepaid forward achieves a couple different objectives.

First, the way that it works is you’ve got a concentrated position and then you can imagine a cap and a floor placed on that concentrated position and then a loan granted against that collared position.

Then the loan is usually something like 75 to 90 % of the notional value of the position. So again, you contribute $100 worth of Google put on the variable prepaid forward. This requires an ISDA, it’s a very complex arrangement, but you put on the variable prepaid forward and then the loan that you’re granted against those $100 would be something like, again, $75 to $90.

What you do with those proceeds is you put them into a diversification program. And nowadays, ideally, that diversification program includes loss harvesting potential such that when the variable prepaid forward matures, you’re able to match losses from the diversification program with gains from winding down the isolated position.

You also retain the optionality to extend the variable prepaid forward. So again, like Frazer, just to your exact point, it’s just like, how do you get from A to B in the most graceful ways? There is just like the whole toolkit to get this done thoughtfully.

Frazer Rice (24:46.506)
Well, one of the things that, you know, if you start talking about the estate tax perspective, one of the tools is the step up in basis when you die. And so for some people who are willing to absorb that concentration risk, sometimes it’s worth holding onto those shares. if the idea is that you’re thinking long-term enough to pass them on to somebody else, you end up getting a step up in basis. Your estate does when those shares, when you pass away and then that capital gains part goes away. Now you have to net that against the estate tax. Fortunately, we have large exemptions in place, but that’s another tool in the toolkit that we think about.

Brent Sullivan (25:23.984)
It’s insanely valuable from a planning perspective. I think you could educate me a little bit here, from the on community property states, you’re going to get spousal step up. tell me about that, because that does come up with some regularity.

Frazer Rice (25:31.84)
Sure. Well, a lot of times you have to be careful in terms of how these are owned so that you don’t get half of it split and half of it not. Essentially there are some States that allow community property to be co-mingled into a trust so that you get the step up immediately.

That deserves its own episode on its own probably. we’ll dive in. We’re going to, dramatic foreshadowing for our listeners, we’ll probably have a separate estate planning one, but

Yeah, no, that’s a big deal where you have to really understand the characterization of the features there of ownership so that you’re not splitting one and not the other if it’s owned jointly.

Brent Sullivan (26:20.794)
Yeah, that’s a fascinating topic. That’s a real planning opportunity in community properties states. There are other solutions too we could get into another time. But just suffice it to say that like the planning opportunities here, this is really the work of an advisor, I feel. It’s not investment selection.

I mean, to a certain extent, it’s investment selection, but it’s design, it’s thoughtful planning, it’s accelerating losses, deferring gains, optimizing gains, using tax as a risk mitigation device. That’s probably a little complex, but this is the work of a thoughtful advisor.

Frazer Rice (26:52.288)
No question about it the it just to get back into the estate planning world even though it just said we’re going to hit the pause button on that one of one of the main things that that in terms of getting things out of one’s estate the the basis carries over and so when you’re doing planning to get away from the estate tax oftentimes you’re not necessarily going to avoid the capital gains tax if you go sort of the simple route

There’s the concept of a grantor tax status where sort of dialing up good estate planning is having the grantor or the donor of the assets into the irrevocable trust pay the taxes on that and that’s done by keeping a set of powers that makes it an incomplete gift.

One of the things that we talked about I think in a different vein was the idea of in a sense having your cake and eating it too where if a grantor is able to put low basis assets into an irrevocable trust for and or maybe low basis and then they grow later so that the growth happens out of the estate maintain the power to substitute those assets which is that’s the real juice here uh… and then be able to substitute those assets that correct fair market and provable valuations through uh… through a firm uh… you know valuation firm.

To substitute it with something like cash that has a high basis so that when you substitute, you’ve gotten the value out of your estate, but then you get the low basis back into your estate so that you can take advantage of the step up later when you pass away.

Is that something that’s come across your desk? I’m sure when people are looking at everything from low basis of stock to companies to so on. We’re seeing it as well where people are saying, okay, you know, what are the best assets to put into these vehicles short and long term so that we try to avoid as much of the different types of taxes that are out there.

Brent Sullivan (28:58.084)
Well, I’m pleased to say that this is definitely a fringe topic. So yes, it comes up for sure, specifically swap power. as deep as we want to go on this, Frazer, we’re more or less bringing what some folks, I think, in estate planning would consider routine practice, where we would be shedding light on it.

Because I think these opportunities are interesting, but I think are rarely discussed out in public. So I mean, that’s really the opportunity for us to create some really interesting knowledge sharing just for the community of listeners or both for my readers. I think this area is, it’s in its nascency if we’re talking about concentrated positions from a public exposure standpoint.

Frazer Rice (29:41.886)
One other thing to put a pin on so we can maybe discuss it and we’re now we’ve now created a whole new podcast not just different episodes but we’re seeing a lot of interest in private placement life insurance and private placement variable annuities really more as a location device in terms of allowing tax-free growth because these is this is life insurance

But then when it’s stitched together with the estate planning component, because oftentimes life insurance is bought in order to match up with the liability of an estate tax. so when someone dies, it’s there. and PPLI is something that we’re seeing a lot more interest in because as a vehicle for owning alternative assets, which are usually high, high, highly taxable, either from an income or otherwise component, why not own it in a vehicle that kills two birds with one stone?

You avoid the taxes on the sort of income and capital gains basis, but then you also get good estate tax treatment if you’re able to own it that way.

Brent Sullivan (30:42.67)
Yeah, totally. I mean, yeah, you’re going to educate me on all that stuff. I mean, that’s that’s one step beyond what I normally encounter, even though I’ve got the PPLI books sitting on my desk over there.

Frazer Rice (30:52.564)
It changes hourly because it’s becoming more more popular as we get going. the, you know, as we sort of, I don’t know if we want to wind down here quite yet, but the one thing that’s interesting here is we get to a, for people who are operating in that estate world with where executors and trustees and people who have what I call fiduciary with a “Capital F” types of roles.

Do you get people asking you, know, what do I have to think about? If I’m an individual owning it, that’s one thing because those people are responsible for their own investments. I maybe they’re getting help from an advisor and there’s some back and forth on that, but the concepts are sort of limited to that person or that generation.

So you start going to the world where you have to probate in a state or then manage a trust with these types of concepts. To me, the functions are important because you’re not only managing assets, like when things go wrong, you’re personally responsible.

And that to me is, think, some of an area where we’re to have to discuss even further what we’re doing here because not having a really steady hand on the wheel and understanding what’s happening underneath all of this.

If you don’t take advantage of these things, not only from an investment perspective, but a tax perspective, that people can come back at you later and that can get ugly. As an example, if you’re in a long short situation and someone passes away, in my mind, you want to wind that down as fast as possible because you don’t want liability to … all of a sudden balloon on you and then all of a sudden the beneficiaries of these states say well why didn’t you wind this down?

Brent Sullivan (32:45.034)
I think that’s one of the most interesting planning opportunities that I’m getting into the weeds in now. And so that’s like, know, just stepping all the way back. If we’ve got a portfolio again, that’s got margin extension and shorts, those are liabilities like on the household balance sheet or on the estate.

Then the typical default behavior is that the estate has to settle all liabilities. Now, of course, if you don’t want to settle the liabilities, you want to exclude these assets from the estate using some vehicle. There’s multiple options. Could be a trust, could be an LLC, family limited partnership, a bunch of different solutions to ensuring continuity if that is the family’s priority. But then to your point, and it’s such a good one, it’s just like, if you do want to use a vehicle that requires a trustee, does the trustee know what’s going on here?

Do they understand that there’s an alpha model and that the alpha model introduces tracking error into the family circumstances and that the portfolio has leverage attached to it?

Now here’s an analogous case here, which might be real estate, The entire balance sheet of the asset passes. I think this is a very common situation in estate planning. Is that a suitable analogy for what’s happening with long short mandates? That investors want to keep on for decades?

There are reasons for doing that, by the way. I mean, part of the reason is that they just want to keep the alpha exposure. Like, hey, this thing is great. I love this relative value. It’s market neutral.

Cool, like let’s keep this going. Another thing is that if the assets are in the estate and someone passes. We’re going to settle and if we have unused capital losses, they essentially evaporate. They don’t pass on. Okay. But if these assets are excluded from the estate, those losses are part of the balance sheet. They just like keep on, they can be continually used by future generations. There are a lot of just different interesting concerns here. To your earlier point, are trustees familiar with what’s going on? Maybe this is actually all routine and I’m just not privy to that, but I think, yeah, I mean.

Frazer Rice (34:51.417)
I’ll tell you right now it’s not. The whole body of law has evolved that way so that there’s a concept called directed trusts. The functions are bifurcated. the mailbox admin component can be one person or one institution. The distribution decisions can be more family oriented, et cetera.

That can be a group of people or an institution. And then the investment part, that can be a different group of people or an institution. a lot of people got frustrated with the idea of having a bank sort of taking control of all that.

Their gut instinct is going to be to diversify because they don’t want to take any investment risk because if something goes wrong, it’s going to be the, you know, the beneficiary on one hand 25 years from now who sues and says, well, you know, why did you do that? In a more familial situation.

The trust law has really, in a sense, stepped ahead of some of these concepts, probably really to deal with the real estate wealth that you were describing before. These new tax alpha strategies are becoming much, much more of an asset and much more of a short and long-term asset that A, have to be taken seriously, and then B, I think have to be managed much more adroitly than I think the typical trustee can deal with.

Brent Sullivan (36:08.388)
Yeah, especially when talking about nuanced expressions of planning. When we’re talking about utilizing these losses very deliberately for a specific purpose. Whether it’s for the trust itself. Because the trust is a taxpayer, it’s got compressed brackets, all of that is a planning opportunity. How is a trustee gonna handle all that? That seems nuanced to me, but it also seems like there’s incentive, I guess, at that point for the… The assets to pass to the heirs like almost as soon as possible for the trustee to mitigate liability. Is is my understanding right there? mean, like.

Frazer Rice (36:46.373)
So the short answer is yes. I mean, if you’re a trustee, you’re set up to be investing as prudently as possible. The real leap forward in the last five years, is these tax tools have become so powerful so quickly. Prudence now has to be looked at on a pre-tax investment perspective and a post-tax perspective.

Then the other sort of component of that is if you’re the trustee of a limited vehicle, just a trust. Whereas you’re advising a whole family and sort of going in between individual ownership and trustee ownership. Pre estate and post estate and things like that. It’s not fair to take somebody to task for that. Especially if they’re the trustee of a specific trust from a pure legal perspective.

I see a big thing coming down the pike. Someday where someone said, the trustee did not take advantage of the tools that were available to us. And we had a tax bill that we shouldn’t have paid. whether shouldn’t, shouldn’t’s doing a lot of work there. And there’s probably going to be a 95 page brief describing the underpinnings of shouldn’t.

But that’s something that I think modern trustees, especially in the directed world. Modern investment directors of these trusts are going to have to really understand well. I think they understand that well in the real estate sense. All the 1031 exchange things have become sort of fait accompli knowledge for people who own that.

These new tax rules on the investment side are going to be important to digest and understand. Both from a strict trustee in the trustee role, but the advisors that are advising.

Brent Sullivan (38:40.496)
I mean, you made this incredible point. The power of these strategies is that it gives additional planning flexibility to advisors. And now you’re saying, OK, trustees also have this additional flexibility. Are they going to be taken to task for not prudently administering the “tax assets” that are sitting on the trust balance sheet now?

That’s a really interesting concept. It’s sort of like if we zoom out we’re saying like these products are actually quite powerful. It’s funny to think about somebody being held accountable for not exercising or using them to their full potential. And that’s an interesting wrinkle, but it’s suffice it to say investors are, I think, well served by these products.

I don’t want to go too far there, but I want to say that these are planning capabilities. These are important arrows in the quiver.

Frazer Rice (39:13.945)
No question.

Brent Sullivan (39:39.894)
They have a suitable profile for an investment household. And I think in certain circumstances, they are just incredibly useful planning devices, especially multi-generation.

Frazer Rice (39:53.518)
Question. Let’s stop there because I think we could go on for four hours. Frankly I need to get my research hat on to know what I’m talking about for four hours. What a treat and Brent how do we how do people get a hold of your blog? How do they find you and stay in touch with your work?

Brent Sullivan (40:14.004)
I’m sorry, I’m very obnoxiously on LinkedIn all the time. This makes some folks shame on us. We’re on the cringe platform, but just having a ball there, it’s fun. But yeah, LinkedIn, you can just search for me, just Brent Sullivan. And then my blog is taxalfainsider.com.

And I’m in market three times a week. So new stuff, and this is usually expert interviews. It’s oftentimes really, I think, some novel research on

Frazer Rice (40:17.527)
Me too.

Frazer Rice (40:23.158)
Exactly.

Brent Sullivan (40:43.95)
These issues specifically. I’m really talking about core portfolio management and nowadays spending a lot more time in estate investigations. So this is highly relevant for me anyway. You can find me at TaxAlphaInsider.com.

Frazer Rice (40:55.563)
Well, and for listeners and watchers on the show, I highly endorse it. learn a lot every time it pops up.I’s got a nice little dose of humor attached to it too, so it’s a lot of fun to read.

Brent Sullivan (41:08.304)
Yeah, mean, you know, we’ve got to keep it light, serious. I mean, this work is deadly serious. We need a refresher every once in a while, just because it’s, yeah, because it’s hard work.

Frazer Rice (41:20.153)
No question. Brent, thanks for being on.

https://www.amazon.com/Wealth-Actually-Intelligent-Decision-Making-1-ebook/dp/B07FPQJJQT/

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