What is Tax Loss Harvesting?
In simple terms, Tax loss harvesting is the practice of selling your investment in shares/securities or mutual funds at a loss. In other words, the process of booking unrealized losses on your portfolio with the aim to minimize capital gain tax is called harvesting.
Now, the amount of capital losses that an investor has booked by offloading his investment can be offset against the capital gains earned on an investment in other securities and mutual funds. In this way, you can reduce your net capital gains for the given financial year, on which the capital gain tax is levied, thereby reducing your tax liabilities or tax burden.
Types of Capital Gain Taxation
Investment in the share market is subject to two types of capital gain taxation obligations; short-term capital gain and long-term capital gain (LTCG). Let’s understand both the capital gain tax implications on traders and investors;
Short-Term Capital Gain (STCG): Profits made by selling stocks or equity mutual fund units held for less than 1 year are called STCG. As per the taxation rules, STCG attracts 15% of the tax rate.
Long-Term Capital Gain (LTCG): Profits earned by offloading stocks or equity mutual fund units that an investor keeps in his portfolio for more than a year are called LTCG. Currently, the rate of tax applicable on LTCG is 10% but LTCG upto Rs. 100,000 are tax-exempted means no tax is charged on capital gains worth Rs. 100,000, and gains above the exemption limit are charged at a 10% tax rate.
How Does Tax Loss Harvesting Work?
Let’s understand tax loss harvesting further with an example to have a clear idea of how it helps to reduce taxes. Two scenarios have been considered; one without harvesting and one with the use of tax-loss harvesting to know the net difference between the amount of tax payable.
Example 1: Tax-Loss Harvesting on Short-term capital gains
Suppose, you have made a short-term capital gain of Rs. 1,50,000 in a financial year, then without harvesting, your tax liability will be as follows;
Short-term capital Gain Tax [without harvesting] = Short-term capital gain * Short-term capital gain tax rate
Now, assume that in the same scenario, the investor is also holding an investment in other shares that are currently running at an unrealized (un-booked) loss of Rs. 60,000. If he wants to get the benefit of tax-loss harvesting he must have to sell or dispose-off such investment at losses. Now, the tax will be as follows;
Net Short-term capital gain [With Harvesting] = Short-Term Capital Gain – Short-Term Capital Loss
= Rs. 1,50,000 – Rs. 60,000
Investor’s net capital gain has been reduced by 60,000 and reported at Rs. 1,10,000, on which 15% tax is applicable such as follows;
Short-term capital Gain Tax [With Tax-loss harvesting]
Net STCG tax difference = Capital Gain Tax (Without Harvesting) - Capital Gain Tax (With Harvesting)
So, the net difference between tax payable without and with harvesting is Rs. 6,000 which means that tax-loss harvesting helps to reduce capital gain tax outgo by Rs. 6,000.
Example 2: Tax-Loss Harvesting on Long-term capital gains
Suppose an investor has earned LTCG of Rs. 4,00,000, so without taking harvesting advantage, the calculation of tax payable will be as follows;
Net LTCG = Total LTCG – Tax-Free/Exemption limit
= Rs. 4,00,000 – Rs. 100,000
LTCG Tax (Without Harvesting) = LTCG *10%
In the second scenario, assuming that the investor also has some stocks in his portfolio for more than a year and currently, he is having a portfolio loss of Rs. 120,000. To take the tax-loss harvesting benefits, the investor sells his entire portfolio at the given losses, now, the LTCG tax will be as follows;
Net LTCG (with harvesting) = LTCG – Tax-free/Exemption limit – Long-term capital loss
= Rs. 400,000 – Rs. 100,000 – Rs. 1,20,000
LTCG tax (with harvesting)
Net LTCG tax difference = LTCG tax without harvesting – LTCG tax with harvesting
Thus, in that case, tax-loss harvesting has reduced the net LTCG tax payable liability by Rs. 12,000
Tax-Loss Harvesting Rules or principles
STCG: Short-term capital losses on your portfolio in a financial period can be set off or compensated against the short-term capital gains as well as long-term capital gains.
LTCG: Long-term capital losses can be set off against long-term capital gains (LTCG) only. It means you cannot be subtracting it from the short-term capital gains.
Important Note: If you only have capital losses both in the short-run and long-run, means you won’t be able to take the advantage of tax-loss harvesting opportunity. Similarly, LTCG upto the exemption limit of Rs. 100,000 does not provide any harvesting benefits.
Log in to the Kite platform.
Go to the Console reporting dashboard.
On the top menu bar, click on the “Reports” option.
Now, tap on the “Tax-loss harvesting” field.
The details about the short-term and long-term tax-harvesting opportunities will be available to you.
Tax-Loss Harvesting: Final Verdict
Hopefully, everything about tax-loss harvesting is crystal clear to you. Now, it is clear that harvesting is simply the way to minimize your net capital gains on which tax rate is applicable by booking unrealized losses. The harvesting opportunity is available on short-term and long-term capital gain and helps an investor to reduce the amount of capital gain tax outgo and thereby get maximum post-tax returns.
Frequently Asked Questions
Tax loss harvesting is a common practice at the Financial year end by selling stocks that are trading in a loss in your portfolio and buying them the next day. This will reduce your total capital gain/ income for the financial year.
If there are no realized profits or if realized losses are greater than the realized profits, there will be no tax-loss harvesting opportunity.
Note: The first 1L of long-term capital gain(LTCG) is tax-free. So this is not considered in the tax-loss harvesting report on Console.
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