Tax-Loss Harvesting

General
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Tax-Loss Harvesting

Tax-loss harvesting reduces taxes by selling loss-making securities and offsetting capital gains. Long-term capital gains (LTCG) over ₹1 lakh are now taxable at 10% without indexation, making this strategy more important since April 2018. Taxes on short-term capital gains are 15%.

Investors can reduce taxable income and boost post-tax returns by selling underperforming stocks. The sale proceeds can be reinvested in similar sector stocks to maintain portfolio valuation.

How Does Tax-Loss Harvesting Work?

Follow these steps to implement tax-loss harvesting:

  1. Identify Underperforming Assets: Pinpoint stocks with consistent losses and low recovery potential.
  2. Sell and Realise Losses: Dispose of these stocks to book the capital losses.
  3. Offset Losses Against Gains: Use the realised losses to reduce your taxable capital gains.
  4. Comply with Set-off Rules:
  • Long-term capital losses can offset only long-term capital gains.
  • Short-term capital losses can offset both long-term and short-term capital gains.

Example: Tax-Loss Harvesting in Action

Let’s explore two scenarios: one without tax-loss harvesting and one after employing the strategy.

Portfolio Overview:

  • Initial Investments (January 2): Stocks A, B, C, and D purchased for ₹400, ₹800, ₹1200, and ₹500 respectively (Total: ₹2900).
  • Current Values (March 20): ₹150, ₹900, ₹1300, and ₹700 respectively.

Scenario 1: Without Tax-Loss Harvesting

  • By the financial year-end, stock prices rise to ₹600, ₹1000, ₹1400, and ₹900.
  • Net STCG: ₹200 + ₹200 + ₹200 + ₹400 = ₹1000.
  • Tax Liability (15%): ₹150.
  • Post-Tax Profit: ₹850.

Scenario 2: After Tax-Loss Harvesting

  • Action: Stock A sold on March 20 at ₹150, booking a ₹350 loss.
  • Adjusting this loss, net STCG is reduced to ₹650.
  • Tax Liability (15%): ₹97.5.
  • Post-Tax Profit: ₹552.5.

The strategy reduces taxable income and overall tax outgo.

Benefits of Tax-Loss Harvesting

Tax-loss harvesting is a long-term savings strategy. This tool can effectively offset capital gains.

  • Cut taxes significantly.
  • Increase after-tax portfolio returns.
  • Rationalise annual gains and losses.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.