‘A Penny Saved is a Penny Earned.’
Now that we are just a few moments from the end of the financial year, every taxpayer in India is devising legitimate ways of reducing taxes. Moreover, that’s what concerns investors making substantial gains in the stock market.
‘The higher the return on investment, the higher the taxable amount.’
You might be aware of some common tax-saving options. But, what if I tell you that you can benefit from the fall in the asset’s value in the portfolio? This means you can make the losses good and maximize post-tax returns.
Isn’t it amusing!
Well, try Tax Loss Harvesting and save taxes on capital gains.
What is Tax Loss Harvesting?
Tax loss Harvesting is a strategy wherein an investor sells the loss-making investment to offset taxable gains from any other investment, thereby reducing tax liability. However, you can purchase the same or similar shares the following day to secure the expected returns.
Erstwhile, the long-term capital gains on the sale of equity shares and equity-oriented funds were fully exempt from tax. However, the Union Budget 2018 introduced the amendment and changed the tax treatment on equity shares or equity-oriented funds sold.
If you sell equity shares or equity-oriented funds after one year of purchase, LTCG (Long-term capital gain) exceeding ₹1,00,000 is taxable at 10% (without indexation). Alternatively, if you sell them within one year of purchase, STCG (short-term capital gain) will be taxed at 15%.
How does tax loss harvesting work?
Tax loss harvesting begins with the sale of underperforming stocks in the portfolio. You might feel these stocks are losing value, and the chances of recovery are bleak. After the loss is realized, you can use it to offset the capital gains earned over a period.
While most investors harvest their losses by the end of the financial year, you can implement this regularly to keep your capital gains at a low level.
Now let’s take an example to understand it better.
Surbhi, a technical professional, has a portfolio wherein she has invested in stocks, equity, and debt mutual funds. At the end of the financial year, Surbhi’s portfolio stands with STCG of ₹10,00,000 and LTCG of ₹20,00,000.
So the tax liability (Before Tax Loss Harvesting) is as follows:
Surbhi is apprehensive about some underperforming stocks or the declining value of certain stocks in the portfolio. On consulting, her investment advisor advised her to use tax loss harvesting.
She immediately decided to sell the shares and booked a short-term loss of ₹1,00,000. Surbhi was also recommended that she can invest the sales proceeds in some profit-making stocks with promising returns.
The tax liability (After Tax Loss Harvesting) is as follows :
Surbhi has successfully reduced the tax liability by ₹15,000 (3,40,000 - 3,25,000) by using tax loss harvesting. Also, reinvestment in good stocks or mutual funds might provide a chance to recover the losses.
Tax loss harvesting is an invaluable tool. It doesn’t reduce your losses but provides an opportunity to reduce the overall taxable liability.
Points to remember before you go ahead with Tax Loss Harvesting.
You can set off a long-term capital loss with long-term capital gains only. However, a short-term capital loss can be adjusted with short-term and long-term capital gains.
The selling of Shares is done on a FIFO basis.
There is no tax loss harvesting opportunity if there are no realized losses.
Tax loss harvesting is for tax-saving purposes only and shouldn’t be confused with investment strategy.
It’s advisable to keep the portfolio’s risk-return profile under control while you go ahead with investing the redemption proceeds of loss-making stocks.
Parting Thoughts!
The expectation of the rise of loss-making stocks often delays the decision to sell. But if you have high realized profits, these losses can be a blessing in disguise. Tax loss harvesting is an effective way to bring down the tax outgo and enhance post-tax returns.
However, before you go ahead, it is crucial to keep an eye on the market conditions. If you feel that a decline in security is temporary, selling it would result in loss and obstruct your compounding journey. Consult your investment advisor before you make the final decision.
You can learn lots about the stock markets on our educational app, School Of Stocks (SoS). We strongly recommend you to stay tuned and read regularly to learn more about capital markets and make well-informed trading and investing decisions.