Tax Loss Harvesting

All About Tax Loss Harvesting

When you invest in equities or equities dominated funds, you are exposed to capital gain tax. The capital gains tax that applies to your investment is based on the horizon of investment. First Check the types of capital gain in income tax:

Types of Capital Gain in Income Tax

Capital gains are categorized into two based on the investment horizon. Following are the two –

  • The capital gains made within a period of one year is known as the Short-term capital gains
  • The capital gains made beyond a period of one year is known as the Long-term capital gains
  • The capital gains made within a period of one year is known as the Short-term capital gains
  • The capital gains made beyond a period of one year is known as the Long-term capital gains

How are the Capital Gains Taxed?

The tax structure for both LTCG and STCG is different. The taxation is shown as under –

FundsShort-term capital gains tax Long-term capital gains tax
Equity Funds 15% 10% (beyond Rs 1 lakh profit annually)
Non-Equity Funds As per income tax slab 20% (with indexation)

Source: Tarrakki Research

For the newbies, there was no LTCG tax applicable previously. But, since Union Budget 2018-19 announced on February 1, 2018.

What is tax loss harvesting?

It is the method in which you try to reduce your tax liability by selling the holdings that are in red. The technique sets off the capital gains made on equity against capital loss. This leads to a reduced tax burden.

How does it work?

Investors adopt the strategy during the financial year-end. Having said that, the approach can be executed at any time of the year.

In this approach, an investor tends to sell the equities or equities dominated instruments that are experiencing a fall in the value. These securities are sold if an investor believes that there is a bleak chance of rebounding from the current level.

The loss thus booked gets adjusted to the capital gains booked in other securities of the portfolio. Doing this lowers the net capital gain for the investor, thereby reducing the tax liability for the year.

Let us see with an example –

Assume an investor Mr. A has booked the following capital gains –

Category Profit Loss Net Profit
LTCG 100000 10000 90000
STCG 15000 2000 13000

Thus, for the financial year, considering your portfolio profits and losses, the tax would be –

Net LTCG x LTCG rate + Net STCG x STCG rate

= 10%x (100000-10000) + 15%x (15000-2000)

= 10%x90000 + 15%x13000

= 9000 + 1950

= 10950

This is the taxation after considering the benefit of tax loss harvesting.

On the other hand, if you have to remove loss in tax harvesting, the taxation would be on the profits, which are –

LTCG x LTCG rate + STCG x STCG rate

= 10%x100000 + 15%x15000

= 10000+2250

= 12500

To know more about the Tax exemptions, read our blog Tax exemptions for the salaried employees.

What should you do with the free money?

An investor would never want to lose out on capital, and neither would want to keep the wealth idle. In this case, as an investor, you should scout for opportunities that are lucrative for investing. The process of replacement is essential and should be done in a manner that the overall portfolio balance is not altered. Also, an investor should keep in mind that the ones should replace the under performers with where he/she has a strong conviction.

Some points regarding points to ponder while implementing tax-loss harvesting

  1. Short-term gains can’t be used to set-off Long-term losses.
  2. An investor should estimate tax liability before executing any loss-making trades.
  3. An investor should assess the risk-return profile of an instrument before investing the released capital
  4. The method should be used only for tax saving. It should not drive investments.

To conclude, tax loss harvesting is an important concept that helps in reducing the tax liability that may arise due to profit booked in the short-term and long-term investments. However, the method should be used only for tax management purposes and should not form the tactic of portfolio management as it may lead to amplified losses if repeated frequently. Should you wish to know more about tax-loss harvesting, feel free to connect with us at info@tarrakki.com. You may subscribe to our blog and join us in the Facebook group once you sign up at Tarrakki – Mutual Fund Investment App.

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