What is Tax Harvesting?How to do Tax Harvesting?
What is Tax Harvesting?
In this episode, we are sticking to Tax harvesting from LTCG in equities.
What is LTCG?
Long capital term gains are the returns you make by selling your equity investments held for more than 12 months
Currently Long-term gains from equity is taxed at 10%. But LTCG upto 1L rupees per year is currently tax free and anything about this is only taxed at 10%. Tax Harvesting is a technique that is used to utilize this option. It utilises the ₹1 Lakh annual LTCG exemption by selling and buying back part of your investment such that you “realise” gains every year. This will reduce the tax you need to pay in the long run.
Now if you are a new investor or beginning in mutual funds, your yearly gains may not cross the Rs. 1 lakh limit immediately. But, when you let your profits run over few years, it will cross the threshold at some point.
Similarly, people who have a large equity portfolio will have higher incremental gains. Therefore, if you want to pay low or no taxes, you need to ensure these gains don’t build up beyond the tax-free limit, and that’s what Tax Harvesting is all about.
So, again, what is tax harvesting?
Tax harvesting is the strategy of selling a part of your mutual fund units to book long term capital gains and reinvesting the proceeds in the same mutual fund
let’s take an example.
Assume you have invested Rs. 2,00,000 in an Equity Mutual fund on Jan 01 2021, and on Jan 05, 2022, the value of this investment becomes Rs. 3,00,000.
Now, if you redeem this, your gains will Rs. 1,00,000, and your tax liability will be zero. That’s because any Equity Investment held for more than 12 months qualify for Long Term Capital Gains, and the tax has to be paid only if gains exceed the limit of Rs.1 lakh in a financial year.
Next, you invest this entire amount, i.e., Rs. 3,00,000 soon after redeeming, preferably on the same day or the next day. Your investment cost will be reset to Rs. 3,00,000, along with the date of investment.
Now, say your investment value increases to Rs. 3,80,000 after another year. When you redeem, your gains will be Rs. 80,000 — which is still less than the Rs. 1 lakh limit. So you don’t have to pay taxes next year as well.
Had you not redeemed and reinvested the amount, your long term gains would have been Rs. 1,80,000 (1L last year and 80K this year), and you would have needed to pay 10% tax on the amount that exceeded the limit of Rs. 1 lakh. So a tax of Rs. 8,000 (10% of 80,000) needs to be paid. Tax savings saves this cost.
You can use this method even when you are investing via SIPs or lumpsums. You can redeem units that you have held for more than 12 months and reinvest. However, if you redeem the units but don’t reinvest, the strategy becomes meaningless.
For more details and examples, checkout: