What is Tax Loss Harvesting? Another intelligent way to save tax?
What is Tax Loss Harvesting: Another way to save tax
In the last episode, we discussed about LTCG tax harvesting, which is a way to reduce the tax burden created by profits from equities. Likewise, we can use any losses we have and use it to reduce taxes as well.
In tax-loss harvesting, you book losses and offset gains in any other instrument to bring down your tax liability.
For example,
Let’s say you have invested Rs. 5 lakh in a equity mutual fund on 1st Jan 2021. And now, on Oct 2021, your investment value is Rs. 4.75 lakhs. If you seel your investment now, in this scenario, your short-term capital loss is Rs. 25,000.
Now, if you sell this investment, you are booking the losses (but do remember to reinvest this money immediately to avoid deviating from your investment plan just for tax saving purpose), and you can use this to offset any short-term capital gains you might have received in the year.
If you cannot use your capital loss to reduce your capital gains in one year, you can carry forward the losses for up to next 8 assessment years.
In the same year or 2–3 years down the line, you sell a short term equity MF investment and make Rs. 50K in capital gains. Since you have gains of Rs. 50,000, you have to pay tax. However, you can remove Rs. 25,000 from the Rs. 50K gain for tax calculation as we have Rs. 25K in short term capital loss.
So your effective STCG will be Rs 50K– Rs. 25K = Rs. 25K and you will pay tax only on Rs. 25,000 as against Rs. 50,000 you would have paid otherwise.
Since STCG is taxed at 15%, you will be paying Rs. 3750 as tax due to tax loss harvesting instead of Rs. 7500.
This is how tax-loss harvesting acts as a critical strategy to save tax for many investors. The same thing can be repeated for LTCG as well.
While setting off losses using tax-loss harvesting, you need to keep the following points in mind:
· Long-term capital losses can be set-off against only long-term capital gains. You cannot set-off long-term capital losses against short-term capital gains.
· Short-term capital losses can be set-off against either short-term capital gains or long-term capital gains.
Tax gain and tax loss harvesting are simple yet vital tool to bring down the taxes you will pay on your equity investments. Remember, you have to reinvest the money as soon as you get the redemption amount in your account to avoid the risk of breaking your compounding journey.
For more details and examples, checkout: