It happens to the best of us. Sometimes we end up making investments, and they take a downturn. One part of us knows that continuing to hold that investment does not make sense, whereas the other part is scared to book losses.

Selling an investment at a loss can be a real downer. Enter tax loss harvesting, a clever strategy to make use of losses to save taxes and rebalance one’s portfolio. So, buckle up and get ready to leverage losses to your advantage.

In this article, we’ll take you through 

  • the concept of tax loss harvesting
  • how capital gains are taxed in India
  • how tax loss harvesting works

What is tax loss harvesting?

March is an important month for taxpayers. With a few days left for the financial year 2023-24 to come to an end, it’s time to make use of government-provided tax exemptions and reduce our tax liability. 

Some of our investments make gains, while a few others make losses. We pay taxes on the gains that we make. However, we do not pay any tax on the losses. In fact, the Income-tax Act allows us to set off the losses with our gains and pay taxes on the net amount.

Let’s assume that you’ve started investing in equity. You make capital gains of ₹1,00,000 and capital losses of ₹10,000. In this case, you have to pay tax only on the net amount of ₹90,000, i.e., ₹1,00,000 – ₹10,000.

Tax loss harvesting involves the selling of those investments which you believe have little or no chance of recovering from their current levels of loss. This loss is then used to offset capital gains that are subject to tax, thereby reducing the tax liability. In addition, investors may reinvest the proceeds into other promising investments to keep their long-term investment goals intact.

How are capital gains taxed in India?

The Indian Income-tax Act categorizes gains into two categories depending on their holding period — short-term capital gains (STCG) and long-term capital gains (LTCG). The following table shows the STCG and LTCG tax rates on equity. However, different investments like debt, real estate, gold, etc.,  are subject to different rates of taxation.

What is Tax Loss Harvesting? How can it help you save taxes in India?

How does tax loss harvesting work?

Let’s use two examples to understand how tax loss harvesting might work for you.

Example 1:

An individual called Juhi has an investment portfolio spread across stocks, mutual funds, and so on. At the end of the financial year, she has

Short-term capital gains = ₹1,00,000 and

Long-term capital gains = ₹1,50,000

Hence, Juhi’s tax liability is as follows:

STCG tax = ₹1,00,000 x 15% = ₹15,000

LTCG tax = (₹1,50,000 – ₹1,00,000) x 10% = ₹5,000

Total tax liability = ₹15,000 + ₹5,000 = ₹20,000

However, Juhi notices that a few stocks in her portfolio are under losses and she believes that there are minimum charges of recovery. Hence it makes sense to use tax loss harvesting.

Juhi sells these stocks and books a short-term capital loss of ₹40,000. She uses the proceeds to invest in more promising securities.

After using tax loss harvesting, her tax liability is as follows:

STCG Tax = (₹1,00,000 – ₹40,000) x 15% = ₹9,000

LTCG tax = ₹5,000

Total tax liability = ₹9,000 + ₹5,000 = ₹14,000

Hence, she manages to save ₹20,000- ₹14,000 = ₹6,000 in tax.

Example 2:

Vaibhav has a stock in his equity portfolio in which he had invested 3 years ago. However, that stock has been down, and he doesn’t think it will recover. He has a loss of ₹50,000 in that stock.

This fiscal year (2023-24) has been a good year for Vaibhav, and he has many profitable positions giving him long-term capital gains (over 12 months of holding). He thinks there is more upside to his stocks and mutual funds and hence doesn’t want to book profit.

However, he reads this blog and decides to sell some stocks on 27th March, 2024, ensuring to book capital gains of ₹1,50,000. He also sells his loss-making stock, thereby booking a ₹50,000 loss.

Now, his net long-term capital gain for FY24 is ₹1,00,000 and he doesn’t need to pay any tax.

He then reinvests in those profitable stocks on the next day, in the same quantity. The price might differ slightly due to one day’s movement, but it may not be much.

In this way, he ensures to reduce his future capital gains.

If there are more such long-term loss-making positions, he can continue setting them off with long-term capital gains to bring the tax to nil.

How to implement tax loss harvesting?

If you wish to implement tax loss harvesting in the context of equity, follow these steps:

  1. Download the tax loss harvesting report by visiting your broker’s app or website.
  2. Details about short-term and long-term harvesting opportunities will be available to you.
  3. Sell those investments which you believe have little to no potential for recovery and book losses.
  4. When looking at STCG, take a look at those investments that you have made between 1st April 2023 and 31st March 2024.
  5. Set off the losses with the gains and lower your tax liability by paying taxes on the net amount.
  6. Reinvest the proceeds in another asset that fits your investment strategy.

How can you set off losses?

Long-term capital losses can be offset only against long-term capital gains. However, short-term capital losses can be offset with both long-term and short-term capital gains.

Stocks are bought and sold according to the FIFO method (first-in-first-out). Basically, the stocks which are bought on an earlier date are sold first. This helps in determining the holding period and capital gains tax is calculated accordingly.

Stocks and mutual funds are both considered as equity when availing the exemption of ₹1,00,000 for LTCG taxation.

Things to keep in mind

  • Tax loss harvesting does not apply to gains or losses made on intraday trading and futures and options as gains made on these do not classify as capital gains. They are considered speculative gains and charged under business income of the Income-tax Act
  • Ensure that tax loss harvesting does not interfere with your overall investment plan. Keep the wider perspective in mind. Selling an asset at a loss should align with your long-term goals
  • Think of additional costs like exit loads and brokerage costs when you are harvesting your losses and check if it is feasible to do so

In Closing

Tax loss harvesting is a simple yet effective strategy that can help individuals reduce their tax liability significantly. By understanding the nuances of this strategy and adhering to legal guidelines, investors can use setbacks for tax saving and portfolio optimization.