Tax Loss Harvesting - Introduction, How it Works and Things to Keep in Mind

What if you could take advantage of a fall in the value of the asset in the portfolio? Are you wondering how it is 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 the life of a portfolio.  

Tax Loss Harvesting: An Introduction

Tax-loss harvesting is a strategy in which an investor sells loss-making investments to offset taxable gains from other investments, effectively reducing their overall tax liability. This technique is particularly useful for investors who have experienced lower-than-expected returns from some of their stocks or mutual funds. By strategically selling these underperforming assets, you can set off losses against the gains made in your portfolio, thus reducing your overall tax liability. 

How does Tax Loss Harvesting Work?

• Identify Underperformers: You first have to assess your portfolio for investments that have decreased in value.
• Realise Losses: You have to sell these underperforming assets and book losses.
• Offset Gains: Use the realised losses to neutralize capital gains from other investments.
• Strategic Timing: While often done at the year's end, regular implementation can help manage taxes effectively.

Rules for Setting Off Capital Losses in Tax-Loss Harvesting

While setting off losses using tax-loss harvesting, you need to keep the 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.

Tax Loss Harvesting Example

Ravi had earned from listed equity shares an amount of Rs. 6,00,000 in short-term capital gains (STCG) and Rs.15,00,000 in long-term capital gains (LTCG). He was worried about certain underperforming stocks and sold them and realised Rs. 2,00,000 short-term capital loss.

Before Tax-Loss Harvesting:

After Tax-Loss Harvesting: