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In your article, “When Flexibility Counts,” you discuss how munis can be used in a tax swap. But isn’t the tax “advantage” neutral (other than a slight timing play)? You can take a capital loss by exchanging bonds that are down, but wouldn’t it be offset by the capital gain incurred when the new bonds are ultimately redeemed or sold?- F.M., Pennsylvania
Regarding the “timing play” you mention: The replacement bonds in our “swap” illustration would have had long term maturities (20 to 30 years). It is always advantageous to defer taxes to a later date rather than paying them in current dollars. If, however, an investor passes before the bonds mature, they are inherited by the beneficiaries with a new "date of death" cost basis. Had this occurred any time during the last 10 to 20 years, there would likely be no tax due at maturity.
This is why we encourage investors of every age – young and old – to buy long-term bonds: Maximize income during your lifetime! Should you pass, the bonds are treated as cash in your estate. It’s a winner for you and your beneficiaries.
I heard a radio host say that pricing muni bonds is an art, not a science. How are daily prices determined? It would seem by supply and demand for certain issues.
- C.M., New Jersey
We think what the radio host meant was that bid prices are determined by various factors that go far beyond rating, coupon rate, maturity and credit quality.
For this reason, the computer (matrix) pricing you see on your brokerage statement is notoriously imprecise.
Besides the supply and demand element you mentioned, consideration must be given to geographic location, state and local taxes, the purpose of the borrowing, as well as current market conditions, call history and any other individual nuances of the particular security.
I would be interested in your outlook on long-term Puerto Rico bonds, which are currently priced below par although they offer an attractive yield that may remain double tax-free.
- R.C., Arizona
It is no secret that Puerto Rico faces some fiscal challenges today as well as in future years, but some analysts believe there may be reasons for optimism.
New Gov. Alejandro Garcia Padilla has vowed to bring Puerto Rico's fiscal house in order and recently signed a pension reform bill into law.
Most Puerto Rico issues were downgraded by the rating agencies, which had a dampening effect on market values.
We don't believe that Puerto Rico bonds are in danger of default anytime soon, but as Puerto Rico Treasury Secretary Melba Acosto Febo said, "We have a long way to go, but we are hopeful that we will soon begin to see the fruits of our efforts to eventually restore government finances and stimulate our economy."
As for purchasing Puerto Rico bonds at this time, one must consider the reason they provide yields well in excess of other investment-grade bonds, and that prices will continue to be volatile due to ongoing "headline risk." Individual investors must gauge their own risk tolerance when contemplating any investment.
This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.