As we approach the end of the financial year, investors review their investment positions in equity shares, mutual funds and strategically sell assets to optimize the tax situation before the year concludes by using Tax Loss Harvesting.
What is Tax Loss Harvesting?
Tax-loss harvesting is a strategy used to minimise tax liability by selling investments that have declined or are declining in value. The idea is to use the capital losses from investments that didn’t do well to balance out the capital gains from ones that did well.
This way, it provides following benefits:
- Helps to lower the tax liability while allowing to rebalance the portfolio.
- The funds gained from selling underperforming assets can be redirected into more promising investment opportunities.
How does Tax Loss Harvesting Works?
Rajat has an investment portfolio which performed as follows at the end of financial year:
- Short Term Capital Gains: Rs.50,000
- Long Term Capital Gains: Rs.2,00,000
Tax Liability is as follows:
- STCG Tax: 50000 * 15% = Rs.7,500
- LTCG Tax: (200000 – 100000) * 10% = Rs.10,000
Total tax liability = 7,500 + 10,000 = Rs.17,500
Rajat has some stocks in the portfolio which has very less chances of recovery. He books loss of Rs.20,000 by selling these stocks. Then, he puts the money by investing in stocks or mutual funds that offer greater potential.
Now Tax Liability is as follows:
- STCG Tax: (50000 – 20000) * 15% = Rs.4,500
- LTCG Tax: Rs.10,000
Total tax liability = 4,500 + 10,000 = Rs.14,500
Thus, by engaging in tax loss harvesting, tax liability is reduced by Rs.3,000.
Important points to keep in mind:
- Remove the underperforming stocks or funds from the portfolio and not the goods stocks or funds that are undergoing minor setbacks in the short term.
- Long-term capital losses can only be set off against long-term capital gains. Short-term capital losses can be set off against long-term and short-term capital gains.
- Long Term Capital gains are exempt up to Rs. One lakh per year from capital gains tax.
