Investing in equity or equity-based funds result in capital gain.
This capital gain is taxable depending on the investment horizon. For example, any capital gain made within the one-year period is taxed as per short-term capital gain (STCG) tax rate, whereas the gains made by holding the investment for over one year is taxed at long-term capital gains (LTCG) tax rate.
For our novice readers, previously there was no long-term capital gains tax applicable to your investments that were held for more than 12 months.
However, during the Union Budget 2018-19 announced on February 1, 2018, the finance minister re-introduced long-term capital gains tax.
The LTCG made more than Rs. 1 lakh is taxed at 10% without indexation while the STCG is taxed at 15%.
What is tax loss harvesting?
In tax loss harvesting, you sell your holdings at a loss.
This tactic is aimed to reduce your tax liability on other capital gains. This method is used to offset the capital gains made on equity against the capital losses suffered by an investor. It thus reduces the tax burden.’
How does tax loss harvesting work?
Investors prefer this strategy typically during the end of the financial year when tax planning is done. However, this strategy can be adopted/executed at any time of the year.
In the approach, an investor typically sells the equity or equity dominated fund that is experiencing consistent fall in price. The sell is done when an investor feels that the chances of rebounding from the current levels are bleak.
The loss thus booked is then adjusted against the capital gain of the year. This method lowers the net capital gain for the year. Thus, the tax liability reduces in the hands of the investor.
Let me give you an example:
|STCG profit||Rs. 10,000|
|STCG loss||Rs. 5000|
|LTCG profit||Rs. 25,000|
|LTCG loss||Rs. 5,000|
For fiscal 2019, assume your portfolio made the following profits and losses –
Thus, the tax payable under the two scenarios would be –
Without tax loss harvesting = (15%*10000+ 10%*25000) = Rs 4000
With tax loss harvesting = (15%*(10000-5000) + 10%*(25000-5000)) = Rs 2750
Is that all?
Not really. Because, as an investor, you would not want to lose out on capital and neither would you keep your wealth idle.
What should you do then?
We believe the amount you released post sale of the loss-making security should be invested in any lucrative stock or equity fund.
This process is a replacement and is essential to ensure that the asset allocation of the overall portfolio is not altered and your portfolio provides an accurate reflection of your conviction.
Points to ponder while implementing tax loss harvesting
1.Long-term capital gains are used to set-off long-term capital losses only. Long-term capital losses cannot be set-off against short-term capital gain.
2.Short-term capital losses can be set-off using short-term capital gain or long-term capital gain both.
3.Estimate your tax liability before executing any loss-making trade. This shall help you get an estimate on how much tax liability you can save by implementing the deal.
4. Assess the risk-return profile of the alternative investment instrument or scrip where you seek to invest the released capital from the loss-making sale.
5.Use tax loss harvesting only as a tax saving tactic. Never make it drive your investments. If the latter happens, you eventually end up losing your overall investment goals that can jeopardize your financial plan.
We hope that you have derived a fair knowledge about tax loss harvesting and the given examples have helped you, understand the concept better.
Disclaimer: The views expressed in this post are that of the author and not those of Groww