02

Tax alpha is the most popular alpha

Over the past decade, wealth advisors and family offices have focused more and more on tax alpha to show value beyond the traditional sources: pre-tax returns, diversification, asset allocation, and manager selection. Large amounts of capital have flowed into tax-aware strategies for the public markets. Direct indexing tracks an index while harvesting losses on individual stocks.

Beta-neutral long/short strategies hold hedged portfolios that earn little market return and exist mainly to defer taxes through ongoing loss harvesting. These strategies have become a crowded trade. Some platforms now limit them to their largest clients, and regulators are scrutinizing the more highly levered versions and those dedicated to shielding active income.

03

Growth of passive income sources

Family offices and high-net-worth investors have moved well beyond stock and bond portfolios into private equity, real estate, and other pass-through investments. Their tax liabilities look very different from those of tax-exempt institutions. The IRS treats passive income from these holdings differently from portfolio income, the dividends and capital gains that public-market tax strategies are built to offset.

Passive income sources can include:

• Direct rental property and real estate syndications
• Net-lease and ground-lease investments
• LP interests in private equity funds and PE-style LLCs
• Search fund and independent sponsor structures
• Minority interests in operating businesses
• Franchise ownership with a hired operator

Up until this point, there has been no widely utilized investment strategy to defer taxes on passive income with manageable investment risk. Some investors buy asset-heavy businesses, such as laundromats or multifamily buildings, to deduct the equipment inside them. Those deductions aren’t dollar-for-dollar, and they come with leverage, operating, and business-specific risk.

05

Tax leases are a well-established financing tool

In the leasing industry, fair market value leases, also called tax leases, have long been a secondary product to finance leases. Under a tax lease, the lessor keeps title to the equipment and takes the depreciation deduction. The lessee gets to use the equipment and leaves the resale risk with the lessor. Banks, captive finance companies, and independent lessors have deducted equipment depreciation against their other income for decades. Most private investors haven’t realized they can do the same.

Equipment finance is a $1.3 trillion industry, and most industrial and construction equipment is acquired through financing, with leasing the most common method. Some large family offices have built their own leasing platforms. Most high-net-worth investors have no direct access to the asset class.