The Tax Option in Municipal Bonds

Abstract

Tax-loss harvesting is an idea that has been around for decades. This article tries to quantify the value of this tax option embedded in municipal bonds. The authors first develop an algorithm that optimizes the timing of taking tax losses. Using this algorithm, they determine the expected tax benefit that can be extracted over a bond’s lifetime. Under realistic assumptions, the value of the tax option embedded in a long-term bond amounts to several points.