Tax Loss Harvesting: As an investor, you earn capital gains irrespective of the asset you invest in. These capital gains are a part of your taxable income based on how long you stay invested in the asset.
While you trade or invest a significant amount of capital and receive good returns, there comes a time when you start worrying about the taxes on those gains.
So, what will you do at such times when you don’t really want to pay much tax on your capital gains? Is there any alternative to that?
Yes, there is a solution, or it’s better to call it a strategy to reduce taxes on such large amounts of capital gains. What is it? It is called Tax Loss Harvesting. The idea of tax loss harvesting is to reduce the taxes you owe on your investments.
But now, you might be thinking, what is it and how does it work? To get all the answers, continue reading till the end to learn more about tax loss harvesting.
What Exactly is Tax Loss Harvesting?
Based on how long you have held the asset, the tax you pay depends on whether it’s short-term capital gains (STCG) or long-term capital gains (LTCG). Just like you get taxed on the money you make (capital gains), you also get taxed on losses. This is where Tax Loss Harvesting comes in handy for investors, where the taxes on losses will offset the taxes on gains.
In simple terms, tax-loss harvesting is the practice of selling stocks or funds at a loss to reduce taxes on any income from capital gains.
It’s a method to offset the capital gains made on equity against the capital losses suffered to pay a lesser amount of tax.
So here, instead of paying taxes on entire capital gains, you only pay taxes on your net profit, or the amount you’ve gained minus the amount you lost.
But here’s the catch: You can reduce taxes indirectly by selling a stock at a loss to offset the gains. But once this is done, you should buy a similar performing asset to keep your investment game strong and to diversify and balance your portfolio. And remember, long-term losses can only offset long-term gains, and the same goes for short-term losses.
How are Capital Gains Taxed?
Earlier, any LTCG made from selling equity shares or equity funds was completely tax-free. However, changes in the union budget have altered the tax treatment on the sale of equity and other investments.
From the beginning of April 1st, 2018, all LTCG on assets exceeding Rs. 1 lakh without indexation in a financial year will be taxed at a rate of 10%, and all STCG from equities will be taxed at 15%.
How does Tax Loss Harvesting work?
Suppose you made Rs. 1.5 lakh in STCG this year. Since you are Rs. 50,000 above the limit, you have to pay tax. The taxes you have to pay will be 15% of incremental Rs. 50,000 that’s about Rs. 7,500, which is a lot.
But, let’s say, you hold a few stocks with an unrealized loss of Rs. 40,000. So, now, what you can do is sell these stocks to reduce your net STCG to Rs. 1.1 lakh (Rs. 1,50,000–Rs. 40,000). This would require paying 15% in taxes of Rs. 10,000 and you only pay Rs. 1,500 in taxes, saving you Rs. 6,000 in taxes. Pretty good savings, right?
That’s tax-loss harvesting for you—selling stocks strategically to cut down on taxes and keep more in your pocket!
Have you ever tried Tax Loss Harvesting?
Written By Shivani Singh
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