On the client’s tax return, short-term losses offset short-term gains, which are taxed at ordinary rates, and long-term losses offset long-term gains. The results are then combined to produce the client’s net gain or loss for the year, said David Weinstock, a partner in the Manhattan office of Mazars USA Wealth Advisors LLC. He begins harvesting by looking for short-term losses because they offset the client’s highest-taxed income.
Loss harvesting provides current tax savings, but “it really is nothing more than a tax-deferral mechanism,” Weinstock said. Suppose the client has a large-cap fund with a $75,000 basis that is now worth $50,000 and it is sold for a loss. Then the client puts $50,000 into a different large-cap fund. Though the loss can offset current year gains, when the new holding is sold later, its gain will be $25,000 larger than a gain on the original $75,000-basis position would have been if the client had continued to own it rather than sold it to realize a loss.
To accurately project the client’s economic benefit from a loss, consider trading costs as well as state taxes. For example, New Jersey and Pennsylvania don’t let losses offset ordinary income and they can’t be carried forward, Traphagen said.
Proactively communicate with clients, advises Bruce Primeau, president of Summit Wealth Advocates LLC in Prior Lake, Minn. “We sent out e-mails saying, ‘We made a lateral move. You were never out of the market and we harvested X amount of losses to deduct on your tax return.’ And really, that minimized the phone calls we got from clients.”