The Tax Benefits of Private Markets Most Investors Don’t Know About

Most investors think of private markets as a way to diversify beyond stocks and bonds. That’s true, but for high-income earners, the more compelling reason to pay attention may actually be the tax advantages. The right private market investments don’t just add return potential. They may help reduce what you owe.

But the tax benefits don’t exist in a vacuum. To understand why they matter, it helps to first understand what makes private markets worth considering in the first place.

Diversifying Outside Public Markets

Private equity offers exposure to companies and sectors that aren’t (and may never be) available through public exchanges. As part of a diversified portfolio, they can help certain investors reduce their reliance on a narrow group of public market leaders.

Beyond exposure to new opportunities, private markets may help reduce exposure to stock market volatility. While the stock market is heavily driven by investor sentiment, private investments are typically valued at periodic intervals and carried forward with a longer-term mindset. This structure can lend itself well to more intentional tax planning, since transactions and movements happen less frequently.

Finding Private Market Opportunities to Manage Taxes

Private market investors may have access to certain specialized investment vehicles, like tax-aware hedge funds, which are built to maximize after-tax returns. Unlike traditional hedge funds that focus primarily on returns and “hedging” against volatility, tax-aware hedge funds are specifically designed to offset ordinary income that you recognize from a W-2, investment interest, or even a Roth conversion. Another effective tax strategy, designed to harvest capital gain losses, and one of the most effective tools for managing longer-term capital gains taxes, is the long/short separately managed account, or SMA, which we’ll get into below.

Leveraging Separately Managed Accounts (SMAs)

Using long/short separately managed accounts (SMAs), investors harvest capital losses more strategically to offset a large taxable event.

Here’s how it works: A tax-aware long and short SMA helps investors intentionally realize losses in certain positions while maintaining overall market exposure. Those realized losses can be held and carried forward for future use. When a significant taxable event occurs, those stored losses may be used to offset capital gains.  This strategy can also be used to divest a highly concentrated stock position.

Such a strategy can create loss harvesting flexibility for certain people, including:

• Business owners or shareholders preparing for an exit
• Executives with a significant amount of company stock
• Investors preparing to sell off a large amount of highly appreciated stock

Rather than scrambling to reduce a tax bill after the fact, a long/short SMA strategy leverages losses that have already been generated and positions them strategically in advance.

Selecting a Manager

The key to accessing and leveraging the tax-saving capabilities of the private market is to work with the right manager. Not all managers have the expertise or discipline to execute a long/short SMA strategy effectively. It requires careful tax management, consistent monitoring, and a long-term focus.

When evaluating managers, look for a documented track record of tax-loss harvesting results, transparent reporting on after-tax performance, and clear communication about how they manage around taxable events. A manager who can’t clearly explain their tax management process probably isn’t prioritizing it.

It may be worth the extra time and research to find a manager with a proven history of successfully pursuing private market tax opportunities. Doing so may help improve your eventual tax savings and ability to achieve potentially higher returns.

Considering Real Assets

Not all investment income is taxed the same way, and in private markets, that distinction can work in your favor. Private market opportunities come in many forms, including real estate funds, which can generate ongoing income that’s treated differently than traditional dividends or bond interest — often in ways that favor the investor.

Private real estate, for example, gives investors access to depreciation, a tax benefit that can offset a portion of the income generated by the investment. The result is that investors may receive cash flow while recognizing less taxable income than they would from a comparable public market investment. Keep in mind that depreciation benefits can vary depending on your income and how the fund is structured, and they may be partially recaptured when the investment is sold. It’s one of those areas where the details matter, and a knowledgeable advisor can help you understand what to expect.

Beyond the tax advantages, private real estate may also offer some cushion against inflation risk. Rental rates and property values are generally not as inflation-sensitive as other assets, and property owners may be able to adjust rents over time to help preserve purchasing power. 

Real assets like private real estate can complement traditional stock and bond allocations by adding a different risk, return, and tax profile. For high-income earners already managing a significant tax burden, that’s one more reason to take a closer look at what private markets can offer, not just for growth, but for how income is generated and taxed along the way.

Is Private Market Investing Right for You?

While private markets can offer investors access to more diversified opportunities, they’re not right or accessible for everyone. In many cases, you will need to meet accreditation requirements to participate in certain investments (including hedge funds and private equity). There are varying levels of accreditation, so be sure you are transparent with your advisor and fund manager about your investable assets and what you own.

Accreditation aside, private market investing generally creates long-term commitments that lock up liquidity and may expose your capital to higher risk. While the potential trade-offs may be worth it depending on your goals, review the pros and cons with a knowledgeable advisor before moving your money around.

The strategies outlined here work best when they’re planned well in advance, not after a taxable event has already happened. If any of this resonates with your situation, it’s worth having a conversation sooner rather than later. Reach out to our team and let’s talk through what might make sense for you.

This article was originally published here and is republished on Wealthtender with permission.

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