Tax Loss Harvesting

Tax Loss Harvesting India

Tax Loss Harvesting is a strategy of selling underperforming stocks in your investment portfolio to offset capital gains and decrease your tax liability. By doing so, you can enhance tax-adjusted returns on your portfolio. India introduced a long-term capital gains tax on equity in 2018, with a 10% tax on gains above INR 1 lakh per year. To avoid this tax, investors use tax loss harvesting by selling underperforming investments to offset gains with losses.

What Is Tax Loss Harvesting?

Tax loss harvesting is a strategy that investors can use to reduce their tax liabilities by selling off underperforming securities in their portfolios. The strategy involves selling stocks or equity funds that have continuously been underperforming and have little chance of a price reversal, realizing the losses, and then adjusting those losses against capital gains. By doing so, investors can reduce their tax liability and improve their post-tax returns on their portfolios.

However, it’s important to note that tax loss harvesting should not be the sole factor in investment decisions. It’s essential to consider other factors, such as investment goals, risk tolerance, and overall market conditions before making any investment decisions. 

Additionally, investors should consult with a tax professional or financial advisor before implementing a tax loss harvesting strategy to ensure that it aligns with their overall financial goals and objectives.

Tax harvesting for STCG

In the case of short-term capital gains (STCG), tax loss harvesting works as follows. 

If an investor earns a profit from the sale of securities held for less than 12 months, it is considered as STCG. The tax rate on STCG is higher than long-term capital gains (LTCG) in India. As of the financial year 2022-23, the tax rate on STCG is 15%.

Suppose an investor earns Rs. 1 lakh as STCG in a financial year. This means the investor will have to pay Rs. 15,000 as tax on the gains. However, if the investor also has securities in their portfolio that have unrealized losses of, say, Rs. 40,000, they can use tax loss harvesting to offset the gains and reduce their tax liability. 

By selling the loss-making securities, the investor can bring down their net STCG to Rs. 60,000 (i.e., Rs. 1 lakh – Rs. 40,000). This will result in a tax liability of Rs. 9,000 (i.e., 15% of Rs. 60,000), saving the investor Rs. 6,000 in taxes.

Tax harvesting for LTCG

Tax harvesting can also be used to minimize taxes on long-term capital gains. Long-term capital gains (LTCG) are profits made on the sale of securities or fund units held for more than 12 months. Since the tax rates on LTCG are lower than those for short-term capital gains, tax harvesting is less commonly used for LTCG.

Suppose an investor earns LTCG of Rs. 1 lakh in a financial year. The applicable tax rate will be 10% of the earnings. This means that the investor would have to pay Rs. 10,000 in taxes. If the investor has securities or mutual fund units that have an unrealized loss of Rs. 50,000, they can use tax harvesting to reduce their tax liability. 

By selling the loss-making securities, the net LTCG can be reduced to Rs. 50,000. This will reduce the applicable tax to Rs. 5,000, allowing the investor to save Rs. 5,000 in taxes.

Tax Loss Harvesting Example

Let’s assume that during the financial year 2022, you had a long-term capital gain of INR 1,50,000 and a short-term capital gain of INR 50,000. However, you also had a loss of INR 30,000 from a particular stock in your portfolio. 

Your tax liability would be calculated as follows:

LTCG tax: 1,50,000 – 1,00,000 = 50,000 * 10% = INR 5,000

STCG tax: 50,000 * 15% = INR 7,500

Total tax liability is INR 12,500

However, if you apply tax loss harvesting strategy, the calculation changes:

LTCG tax: 1,50,000 – 1,00,000 = 50,000 * 10% = INR 5,000

STCG tax: (50,000 – 30,000) * 15% = INR 3,000

Total tax liability is INR 8,000

In this example, by selling the underperforming stock and applying tax loss harvesting, you were able to reduce your tax liability by INR 4,500.

What is the benefit of tax harvesting?

Here are some key benefits of tax-loss harvesting:

  • Reduces tax liability: By offsetting gains with losses, tax-loss harvesting can help reduce the overall tax liability of an investor.
  • Improves after-tax returns: Since taxes can eat into investment returns, tax-loss harvesting can improve an investor’s after-tax returns by reducing the amount of taxes owed.
  • Helps maintain portfolio diversification: Instead of simply selling losing investments, tax-loss harvesting allows investors to sell underperforming investments while maintaining the overall asset allocation and diversification of their portfolio.
  • Provides an opportunity to reinvest: By selling losing investments and reinvesting the proceeds, investors have the potential to recover losses and generate future gains.
  • Can be done annually: Tax-loss harvesting is an ongoing process that can be done every year, providing investors with a continuous opportunity to improve their after-tax returns.
  • Reduces overall investment risk: By selling underperforming investments and investing in more promising ones, tax-loss harvesting can help reduce the overall investment risk in a portfolio.

How to begin tax loss harvesting via Alice Blue?

Here’s how to begin tax loss harvesting via Alice Blue if you are not a client:

  1. Open an account with Alice Blue: In order to start tax loss harvesting with Alice Blue, you will need to open a trading and demat account with them. You can do this online by visiting their website and following the steps provided.
  2. Assess your portfolio: Once you have opened an account, transfer your existing stocks or mutual funds to your Alice Blue account, and then we will help you identify opportunities to harvest losses when you have capital gains to offset. 

If you are an Alice Blue Client: 

  1. Visit the BOT Portal and Login
  2. Once you are logged in, click on “Reports” and select “Tax-loss Harvesting.” 
  3. You will find the complete tax loss harvesting report

What Is Tax Loss Harvesting Strategy?

Tax loss harvesting is an investment strategy used to reduce taxes on investment gains by selling investments that have decreased in value, resulting in a capital loss. The capital loss can be used to offset taxable capital gains. 

The strategy involves selling the losing investment and using the proceeds to purchase a similar, but not identical, investment. This keeps the overall investment portfolio intact, while also realizing a tax benefit.

For example, if you sold stock A for Rs. 10,000 but had purchased it for Rs. 15,000 earlier in the year (resulting in a Rs. 5,000 capital loss), then you could use this amount as a deduction against any profits made on another investment during the same period (such as stock B). The result would be lower total taxable income due at filing time.

Here are the key points to know about the tax loss harvesting strategy:

  1. Timing matters: Tax loss harvesting is most effective when you can use capital losses to offset capital gains in the same tax year. This allows you to reduce your taxes on investment gains and keep more of your money. 
  2. Tax loss harvesting can be automated: Many online investment platforms offer tax loss harvesting as a service, which can be automated to help you save time and ensure you’re maximizing your tax benefits.
  3. Monitor your portfolio: Tax loss harvesting requires careful monitoring of your portfolio to identify opportunities to sell securities at a loss. Make sure you are regularly reviewing your portfolio and identifying opportunities to harvest tax losses.

Quick Summary

  • Tax loss harvesting is a strategy that investors can use to reduce their tax liabilities by selling off underperforming securities in their portfolios.
  • The strategy involves selling stocks or equity funds that have continuously been underperforming and have little chance of a price reversal, realizing the losses, and then adjusting those losses against capital gains.
  • Tax loss harvesting can help maintain portfolio diversification, reduce overall investment risk, and provide an opportunity to reinvest. 
  • To start tax loss harvesting with Alice Blue, open a trading and demat account here. Transfer your existing stocks or mutual funds to your Alice Blue account, and we will help you identify opportunities to harvest losses to offset capital gains in your portfolio.
  • Tax-loss harvesting strategies offer many potential benefits for savvy investors looking for ways to maximize returns while also minimizing taxes owed annually at filing time. It is suitable for those who understand how they work and may find them quite useful when managing long-term wealth accumulation plans effectively. 

Frequently Asked Questions

1. Tax Loss Harvesting Meaning

Tax Loss Harvesting is a tax-efficient investment technique used by individuals to offset their capital earnings by realizing losses. For example, if an investor has a portfolio of stocks and one of the stocks has decreased in value, the investor can sell that stock at a loss and use the loss to offset the capital gains taxes owed on the profits made from other investments.

2. Is tax loss harvesting worth it?

Tax loss harvesting is definitely worth it, as it helps in reducing tax liability and improving portfolio performance. However, it depends on individual circumstances, including the amount of taxes saved and the potential impact on investment returns.

There are also some potential drawbacks to consider, such as:

  • Transaction costs: Selling assets to harvest losses can generate transaction costs.
  • Market timing risk: Tax loss harvesting requires selling assets that have lost value, which may result in missed opportunities if the market rebounds.

3. How much can you tax loss harvest?

Tax loss harvest allows individuals to offset capital gains taxes by selling underperforming securities. How much can you tax loss harvest depends on several factors, including

  • Tax loss harvest can only be done up to the amount of capital gains earned during the tax year.
  • Tax loss harvesting can only be done on investments that have lost value. If an investor doesn’t have any investments with losses, they cannot use tax loss harvesting to reduce their taxes.

4. What is the downside of tax loss harvesting?

While tax loss harvesting has several benefits, there are also some downsides that investors should keep in mind:

  • Tax loss harvesting involves selling securities at a loss and buying similar ones to maintain the portfolio’s asset allocation. These transactions can result in significant transaction costs, such as brokerage fees, which can reduce the returns earned from the tax loss harvesting strategy.
  • Tax loss harvesting involves selling securities that are performing poorly and buying similar ones to maintain the portfolio’s asset allocation.

5. Is tax loss harvesting legal in India?

Tax loss harvesting is legal in India. There are no restrictions on tax loss harvesting in the country, and it is a commonly used strategy by investors to reduce their tax liability. However, investors must ensure that they follow all the rules and regulations related to tax loss harvesting to avoid any legal issues. 

6. What is the limit for tax loss harvesting?

There is no specific limit for tax loss harvesting in India. However, there are some rules and regulations that investors need to follow while executing the tax loss harvesting strategy.

  • Firstly, investors should only sell those assets that are in a loss position. 
  • Secondly, they can offset their capital losses against capital gains made from the selling of other assets.
  • Investors can carry forward their capital losses for up to eight years and set them off against capital gains in future years. However, investors must ensure that they maintain the minimum holding period for each asset to qualify for long-term capital gains.

7. Is tax loss harvesting risky?

Tax loss harvesting is generally considered a low-risk strategy. However, there are some potential risks associated with it that investors should be aware of.

  • One risk is that tax laws and regulations can change, which could impact the effectiveness of the strategy. 
  • Another risk is that the replacement security chosen to maintain the portfolio’s asset allocation may not perform as well as expected.

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