Tax loss harvesting: How you can save on taxes by booking losses

Got loss-making shares in your portfolio? Don’t worry, you can use that loss to your advantage.

Kavya Balaji   /   January 29, 2021

When you invest in shares or equity mutual funds, you gain from the appreciation in the value of the investment. These are capital gains and you get these gains when you sell the investment. However, you might need to pay taxes on the gains depending on when you sell the investment. This is where tax loss harvesting can help. It can reduce your tax liability on investments. It increases the post-tax returns on your investments.

What is tax loss harvesting?

You will sell your shares or equity mutual funds at a loss to reduce your tax liability. The loss will be adjusted against the gains so that you pay less taxes on your capital gains. This is known as tax loss harvesting. 

Earlier, the long-term capital gains (LTCG) that investors made on the sale of shares and equity mutual funds were completely tax-free. However, in Union Budget 2018, an amendment was made. This has changed the tax treatment of LTCG. Beginning 1 April 2018, LTCG on sale of shares and equity mutual funds of more than Rs. 1 lakh will be taxed at the rate of 10%. Note that there is no indexation benefit for these gains. However, short-term capital gains (STCG) on sale of shares and equity mutual funds are always taxed at a rate of 15%. So, capital gains taxes have to be paid for LTCG and STCG. Tax loss harvesting can help reduce the taxes that you need to pay on these gains. 

You can use tax loss harvesting in India to reduce your tax liability on both LTCG and STCG. Investors might use harvesting for STCG more than LTCG because the tax rates are higher than that of LTCG.

How does tax loss harvesting work?

Investors can use the tax loss harvesting towards the end of the financial year when they have to settle their taxes. However, there is no tax loss harvesting date and you can use it anytime in a financial year to reduce your tax liability for that financial year. 

You need to sell the shares or equity mutual funds where there has been a steady price decline or you are having a loss. It is best to sell investments that are wrong choices and have low prospects of doing well in the long run. Once you book those losses on your portfolio, you can offset the losses against capital gains that your portfolio earned in the financial year.

Here’s an example to help you understand. Let’s say in a given financial year, your portfolio had an STCG and LTCG of Rs. 90,000 and Rs. 1,09,000 respectively. The short-term capital losses were Rs. 70,000.

When you don’t use tax loss harvesting, the tax you need to pay will be Rs. 14,400.

Here’s the calculation. [(Rs. 90,000 * 15%) + {(109,000-100,000) * 10%}] = Rs 14,400

If you use tax loss harvesting, your taxes payable will be Rs. 6,900.

The calculations will be:

[{(Rs 90,000-Rs 50,000) * 15%)} + {(109,000- 100,000) *10%}] = Rs. 6,900.

So, you deduct the short-term capital loss from the short-term capital gains to get the net gains. You will need to pay taxes on these gains. If you need help, you can get in touch with wealth consultants at wealthzi.com.

Once the loss-making investments are sold, the amount received from the sale of the investments can be used to purchase best performing shares and equity mutual funds. Looking for the best mutual funds? Click here for the list. Note that this is necessary even if there are no market downturns because this will help you maintain your original asset allocation. 

Apart from helping you save on taxes; you get to know ways in which you can diversify your portfolio in order to earn higher returns. 

Points to note

When you use tax loss harvesting, remember that long-term capital losses can be set off against only LTCG. You cannot set-off long-term capital losses against STCG. However, short-term capital losses made on your portfolio can be set-off against either STCG or LTCG made in the financial year. 

You will need to understand how capital losses and gains work for your trading account. For instance, most stock brokers follow the FIFO (First In First Out) method for calculating losses and profits. If you have a short-term loss on the shares of a company and you also have long term profits for the shares, you will need to sell the entire holdings in the company to book the short-term capital loss. This happens when you have been buying the shares over the years. So, you have to book the losses as well as profits to use tax loss harvesting for the financial year.
 

Need help with tax loss harvesting? Wealth experts at wealthzi.com can do it for you.

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