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What if you could take advantage from a fall in the value of asset in the portfolio?

Wondering how is it even possible?

Try Tax Loss Harvesting!

Tax Loss Harvesting is an opportunistic way to increase your post-tax returns on investment. Even though an indirect way, tax loss investing can help you maximise wealth accumulation especially in the beginning of life of a portfolio.

 

Tax Loss Harvesting: An introduction

Whenever you invest in equity funds, you make capital gains. These capital gains are taxable based on how long you stayed invested that fund. Tax loss harvesting is used to reduce tax liability on investments.

In tax loss harvesting, you sell your stocks/fund units at a loss in order to reduce your tax liability on capital gains. It is a method to offset the capital gains made on equity against the capital loss suffered to pay lesser amount of tax.

Previously, the long-term capital gains (LTCG) made on sale of equity shares and equity funds were completely tax-free in your hands. However, the amendment made in the union budget 2018 has totally changed the tax treatment of LTCG on sale of listed equity shares and equity funds.

Beginning from 1 April 2018, LTCG made in excess of Rs 1lac will be taxed at the rate of 10% without the benefit of indexation. Compared to that, short-term capital gains (STCG) are taxed at the rate of 15%.

In this case, you can employ tax loss harvesting to reduce the tax liability on both LTCG and STCG. Usually, investors use it for STCG because the tax rates on short-term capital gains are higher than that of long-term capital gains.

 

How does Tax Loss Harvesting work?

Most of the investors prefer using this strategy at the end of the financial year when they need to file returns. But you can use it throughout the year in a planned manner to keep your capital gains at a relatively lower level.

Tax loss harvesting starts with sale of the stock or an equity fund which is experiencing a consistent price decline. You feel that the security has lost most of its value and chances of a rebound are bleak. Once the loss is realised, you offset it against capital gains that your portfolio has earned over the period.

Let’s understand this with an example.

 

Suppose in a given financial year your portfolio made a STCG and LTCG of Rs 1,00,000 and Rs 1,05,000 respectively. The short-term capital losses were Rs 50,000.

Tax payable (Without tax loss harvesting) = [(Rs 100,000 * 15%)+{(105,000-100,000)*10%}] = Rs 15,500

Tax payable (With tax loss harvesting) = [{(Rs 100,000-Rs 50,000) * 15%)}+{(105,000-100,000)*10%}] = Rs 8,000

 

The calculations might seem pretty confusing and time-consuming. You can get assistance on managing and filing LTCG tax at cleartax.in.

The amount realised from the sale of the loss making stock/equity fund can be used to buy a lucrative stock/equity fund. This kind of replacement is necessary to maintain original asset allocation of the portfolio. Moreover, it keeps portfolio’s risk-return profile intact.

Among other measures, tax loss harvesting is an important tool to save a lot on taxes. Additionally, you get to know ways to diversify your portfolio to earn higher returns. It doesn’t help to nullify the losses but it can definitely reduce your suffering by helping you save taxes.

 

Things to keep in mind while Tax Loss Harvesting

While setting off losses using tax loss harvesting, you need to keep following points in mind:

  • 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.

  • Short-term capital losses can be set-off against either short-term capital gains or long-term capital gains.

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