Finding Tax Efficiency in an Era of Increasing Tax Obligations

What’s in this article:

• Tax loss harvesting with direct indexing
• Tax-aware long-short strategies
• Pledged asset lines (PALs) and home equity lines of credit (HELOCs)
• Step-up in basis
• Donor-advised funds (DAF)
• Section 1202 and QSBS
• Relocation and Residency
• Real Estate Advanced Deferral and Reinvestment

The sale of a business, real estate property, or other highly appreciated asset marks a significant milestone for most investors. The tax environment in the Pacific Northwest adds a complex web of tax obligations to these transactions, as families in Oregon and Washington have recently seen substantial changes to income, capital gains, and estate taxes. Evolving state-level tax regimes, juxtaposed with a federal regime that appears to have some certainty for the first time in a generation, will demand a more sophisticated approach to tax efficiency going forward.

Effective wealth management now requires a proactive stance, utilizing a diverse array of strategies to manage, defer, or—in some cases—eliminate capital gains liabilities. Here, we offer several important strategies for investors facing potential capital gains liabilities. Read the article here or continue on below.

Precision in the Public Markets: Tax Loss Harvesting With Direct Indexing and “Tax Alpha”

Tax loss harvesting is a strategy whereby investors can sell positions that have dropped in value in order to realize the loss for tax purposes, offsetting capital gains elsewhere in the portfolio (while purchasing similar securities to stay invested if desired). In the realm of public equities, some investors have shifted from ETFs and mutual funds to direct indexing, offering enhanced tax-loss harvesting opportunities. By owning individual stocks and replicating an index, a direct indexing strategy can systematically harvest losses even when the broader market is trending upward. These capital losses create what we call “tax alpha” or a bucket of realized losses that can be used to offset gains from business exits, portfolio rebalancing, or other capital gain events.

Direct indexing has the power to turn what was a passive investment into an active tax-management tool that works year-round to lower a client’s effective rate. Capital losses carry forward indefinitely for an investor, so even if you don’t have capital gains in the current year to fully utilize the capital losses, you are likely to have them in future years as your wealth continues to evolve over time.

Direct indexing isn’t right for all investors, but whether or not you incorporate direct indexing, you can still make use of tax loss harvesting.

Beyond Direct Indexing: The Evolution of Tax-Aware Long-Short Strategies

If direct indexing is the foundation of modern tax-efficient portfolio management, then tax-aware long-short strategies represent its natural evolution. While direct indexing harvests losses from a standard long-only portfolio, a long-short overlay provides significantly more surface area for tax loss generation. By taking short positions in overvalued or fundamentally weak securities, we can create a portfolio with the ability to generate tax losses even in aggressive bull markets where almost every long position is showing a gain.

To illustrate, this is often executed through a 130/30 structure, meaning that for every $100 of capital, the manager buys $130 of stocks (long) and shorts $30 of stocks. This maintains a 100% net market exposure, effectively expanding the gross investment base to 160%.  By increasing the total “surface area” of the portfolio, the manager gains an additional $60 of active positions—across both the expanded longs and new shorts—from which tax losses can be harvested to offset a client’s external gains. For a client with a multi-million-dollar capital gain from a business sale, these strategies don’t just manage wealth—they can help generate the tax losses that may offset and protect gains.

It’s important to note that a tax-aware long-short strategy comes with a distinct profile of risks and additional costs—it’s no free lunch! These strategies bear added risks that may arise—for example, due to a short squeeze, margin call, or just tracking error from active bets that go wrong. Fees for these strategies generally exceed those for standard direct indexing, and there will likely be additional interest costs associated with the margin loan.

Because of the additional costs and risks associated with tax-aware, long-short strategies, these tactics are not suitable for all investors. High income investors in marginal tax brackets; with large, recurring capital gains; or with concentrated stock positions that need offsetting tend to benefit the most. We generally recommend them for investors with at least $5 million in investments. While not for every investor, deploying a tax-aware long-short strategy can produce meaningful tax deferral opportunities for those with a high degree of financial sophistication and a willingness to tolerate the higher volatility and complexity of the strategy.

For Washington-based investors, it’s important to note that short-term capital losses are not available to offset long-term capital gains in the calculation of Washington’s capital gains tax. This makes the strategy slightly less compelling for Washington residents; however, the federal capital gains benefits still apply.

Liquidity Without Liquidation: The Case for Pledged Asset Lines and HELOCs

One of the most common dilemmas for investors is needing liquidity for a major purchase but facing a significant tax bill if they sell assets to fund the purchase. In the Pacific Northwest, where combined federal and state capital gains rates can approach 35%, selling an asset with a $1,000,000 unrealized gain can often mean sending over $300,000 to the government.

A more efficient alternative may be one in which you leverage your balance sheet through a Pledged Asset Line (PAL) or a Home Equity Line of Credit (HELOC). By using your investment portfolio or real estate as collateral, you can access a flexible line of credit at interest rates that are typically far lower than the tax rates associated with a sale. (Take caution to ensure you do not leverage too much of your collateral during periods of market weakness.)

This approach offers a three-pronged benefit. First, your capital remains fully invested, continuing to grow for your family’s future. Second, the interest paid on the line is often a fraction of what the initial tax cost would be if you sold those assets. And last, the interest may be deductible depending on how the proceeds are used;  HELOC interest generally requires the funds to go toward the home itself, while PAL interest follows its own rules. With a HELOC or PAL, you are borrowing against your future wealth to fund today’s needs while avoiding a permanent tax leakage that would otherwise stall your portfolio’s momentum.

The Preservation of Legacy: Step-Up in Basis

Sometimes the most effective strategy is the decision to hold. The step-up in basis at death remains a vital component of multi-generational wealth transfer as it effectively resets the cost basis of an asset to its fair market value upon the owner’s passing. This allows heirs to sell inherited taxable assets quickly after estate settlement with zero capital gains liability.

To maintain lifestyle and liquidity while waiting for the step-up, many clients utilize PALs or HELOCs, accessing the equity in their portfolios without triggering a taxable event. Reforms to the step-up in basis have been floated among lawmakers; there may come a time when the rules are altered, but for now it remains a powerful tool in managing your capital gains exposure.

Philanthropy as a Financial Engine: Donor-Advised Fund

The donor-advised fund (DAF) remains a cornerstone for investors who wish to combine tax efficiency with a philanthropic legacy. DAFs are charitable accounts held and managed by a hosting organization, generally a large financial institution. Clients can contribute cash, securities, or other assets to a DAF and receive an immediate tax deduction for the contribution (subject to annual limits). Funds are then invested and can be distributed via grants to charitable organizations over time. While the hosting organization has ultimate control over grants, there is often an agreement to provide the donor the right to advise the fund on how grants to charities are made. DAFs offer simplicity and flexibility without administrative complexity and are a great move for contributing capital gains assets to eliminate unrealized gains.

The Power of Structural Exemptions: Section 1202 and QSBS

While limited to a small subset of founders and early investors, the Section 1202 Qualified Small Business Stock (QSBS) exclusion remains one of the most potent capital gains elimination opportunities. For founders and early-stage investors in domestic C-Corps, this provision offers a path to significant tax-free growth. Under the 2026 federal guidelines, for QSBS issued after July 4, 2025, the gross asset limit for qualifying C-Corps was raised to $75 million (with inflation indexing beginning in 2027). Perhaps more importantly for those seeking liquidity, recent adjustments to holding periods now allow for a 50% exclusion after only three years and a 75% exclusion after four years. For those who reach the five-year threshold, the ability to exclude up to $15 million (or $10 million for QSBS issued on or before July 4, 2025) or ten times the original basis represents one of the most potent capital gains elimination opportunities.

However, state-level treatment of QSBS is currently diverging and investors wishing to use this strategy should be aware of these changes. In Oregon, recent legislative movements under Senate Bill 1507 have sought to decouple the state’s tax code from these federal benefits. If this decoupling is fully realized, Oregon founders could find themselves owing a full 9.9% state tax on gains that were otherwise 100% exempt at the federal level. Conversely, Washington state recently declined to pass a similar add-back measure. For the time being, Washington state continues to honor the federal QSBS exclusion, creating a strong incentive for founders and early investors. This discrepancy creates a significant planning gap for Pacific Northwest founders depending on which side of the Columbia River they call home.

The Pacific Northwest Calculus: Relocation and Residency

The decision of where to reside ahead of an exit has become increasingly nuanced. While the historic move from Oregon to Washington to escape income tax remains a common theme, the 2026 landscape is more restrictive. Residence moves should be anchored in real-life living situations; maneuvers made just to dodge taxes could result in audits and/or penalties. Oregon continues to tax capital gains as ordinary income at rates up to 9.9%, while Washington has matured its own capital gains tax, with a 7% rate kicking in on gains above $278,000 and a 9.9% rate on gains over $1 million, significantly narrowing the “tax-free” window that once existed in the state.

Crucially for business owners, the nature of the business you are selling can determine whether a move provides any tax relief at all. Both states utilize sourcing rules that can pull a sale back into their taxing jurisdiction even after you’ve relocated. If a business is involved in a “heavy” industry or sources most of its sales to customers within the region, both states may look through personal residency to the actual location of the customers and assets. This means that for founders in manufacturing or high-volume regional retail, a change in zip code is not necessarily a magic wand. Without careful, coordinated planning between your tax and legal team to navigate these sourcing and apportionment rules, an owner might relocate only to find that Oregon or Washington still maintains taxing authority over the lion’s share of the sale.

Learn more about why wealthy Washington residents are considering alternative states as the tax landscape evolves (and where they are heading) in Coldstream’s article, “The Washington Exodus Begins” here.

The Real Estate Exit Ramp: Advanced Deferral and Reinvestment

We find that many real estate investors share a common goal to transition their portfolio over time from active to passive management. In 2026, two primary strategies dominate this transition, each serving a different stage of an investor’s lifecycle.

The 1031 exchange remains one of the most powerful tools for building a real estate portfolio. By reinvesting the proceeds of a sale of investment property into a new investment property, you can defer 100% of federal and state capital gains taxes if the exchange is structured properly. However, it is important to understand that a 1031 exchange is a continuation of your previous investment, not a brand-new start for depreciation. Your tax basis from the old property carries over to the new one, meaning that you continue exactly where you left off on your original 27.5-year or 39-year depreciation schedule for that portion of the value. However, if you trade up and purchase a more expensive property, the excess basis (new money or debt added to the deal) is treated as a fresh purchase. Under current 2026 rules, this new portion of the asset is eligible for a brand-new depreciation schedule and potentially 100% bonus depreciation if qualified, allowing you to recharge your tax deductions and create a fresh shield for your rental income.

If you are ready to retire from property management entirely but want to avoid a massive tax hit, the Section 721 UPREIT (Umbrella Partnership REIT) is another alternative worth considering. Instead of buying another physical property, you contribute your appreciated real estate into the operating partnership of a Real Estate Investment Trust (REIT). In exchange, you receive Operating Partnership units. This is a tax-deferred transaction in which you trade a single real estate asset for a diversified, professionally managed portfolio of properties. You receive a steady stream of passive income from the REIT (often with favorable tax treatment) and crucially, your OP units can still receive a step-up in basis for your heirs.

Unlike a 1031, a 721 exchange is a one-way street. Once you move your wealth into a REIT structure, you generally cannot use a 1031 to transfer back into a physical property. It is designed to be the final move in a real estate career.

Conclusion

Successful capital gains management in 2026 is no longer about finding a single silver bullet strategy. Instead, it has evolved into a balancing act of coordinating multiple tools to fit a specific timeline and long-term legacy goals. Whether you are generating tax alpha through long-short strategies, leveraging your balance sheet for liquidity without a sale, or navigating the increasingly complex residency requirements of Oregon and Washington, the stakes have never been higher.

We live in a region of the country where a few miles can represent a seven-figure difference in your net after-tax return. As states continue to diverge on issues like QSBS decoupling and the millionaire’s income tax, the default path of simply selling and paying the bill is often the most expensive choice an investor can make. At Coldstream, our goal is to ensure that your wealth remains working for you, your family, and the causes you care about rather than being eroded by avoidable tax leaks. As always, please contact your Coldstream Wealth Manager to determine if any of these tools fit the circumstances and objectives of your family’s wealth.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP^®. CERTIFIED FINANCIAL PLANNER™ and CFP^® in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements. The Certified Exit Planning Advisor (CEPA^®) credential is issued by the Exit Planning Institute.

This article is for informational and educational purposes only and does not constitute legal, tax, or financial advice. The information provided is general in nature and should not be relied upon as a basis for any specific tax planning decision. Readers should consult with qualified legal, tax, and financial professionals regarding their specific circumstances. Coldstream Wealth Management is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training.

Coldstream Wealth Management does not provide legal or tax advice. Only private legal counsel or your tax advisor may recommend the application of this general information to any particular situation. Tax services are offered through Coldstream Tax & Consulting, an affiliate; engagement with the affiliate is separate, subject to its own terms, and clients are under no obligation to use affiliated services.