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Tax Loss Harvesting – Introduction and usage
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Introduction

We may make capital gains whenever we invest in equity funds. These gains are taxable based on how long we have stayed invested in the fund. So we sell securities at a loss (albeit temporarily) to balance out tax liability arising out from capital gains, this is the concept of Tax loss harvesting. This concept can be applied to LTCG as well as STCG. Usually, investors use it for STCG becauseLong-term capital gains are generally taxed at a lower income tax rate than short-term capital gains.

Type of security

Holding period of long term asset

Tax rate of long term capital gain

Tax rate of short term capital gain

Equity shares listed by the company

More than 1 year

10% on gain excess of 1,00,000 (without indexation)

15%

Equity mutual funds

More than 1 year

10% on gain excess of 1,00,000 (without indexation)

15%

Debt mutual funds

More than 2 year

20% after indexation

Normal tax slab rates

How does it works?

It is usually used at the end of the calendar year but you can use it throughout the year in a planned manner to keep your capital gains at a relatively lower level.It is also known as “Tax-loss selling”. It starts with the sale of the stock that is experiencing a constant price decline. An investment that has an unrealized loss is sold against any realized gains. The asset is then sold and is replaced with a similar asset to maintain the risk and return of the portfolio.

Tax loss harvesting cannot restore the previous position of the investor but it can reduce the chances of loss. The costs involved are largely transaction related costs which are very meagre in comparison to the taxes saved.

For example in a given financial year our portfolio made STCG and LTCG of Rs 150000 and Rs 120000 respectively. The short-term capital losses were Rs 70000.

Tax payable without tax loss harvesting = [(150000 * 15%)+{(120000-100000)*10%}] = Rs.24500

Tax payable with tax loss harvesting = [{(150000-70000) * 15%)}+{(120000-100000)*10%}] = Rs.14000

Why is tax loss harvesting used at the end of the financial year?

Many investors do tax loss harvesting in the end of the financial year as it helps in reducing the tax burdens.  It may or may not be the best option for every investor for several reasons, such as:

Increasing Tax Rate

At times, the tax rate –the percentage for the calculation of taxes due-will change to help fund the operations of government entities. Investment losses are more valuable to higher income investors. However, all investors may deduct a portion of investment losses if they choose to do so.

Balancing out portfolio

Offsetting helps to align asset allocation in your portfolio. As you balance out, look at which holdings to buy and sell, the adjusted cost, original purchase value the return and risks.

Capital Gains Are Not Equal

Short term capital gains are those which are held for a year or less whereas long term capital gains are held for more than a year.

  1. Long term capital losses can be set-off against only long-term capital gains. You cannot set-off long-term capital losses against short-term capital gains.
  2. Short-term capital losses can be set-off against either short-term capital gains or long-term capital gains.

Tax loss harvesting is not an investment strategy. It is one tactic that can be used toward achieving your financial goals.

 

Disclaimer 

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