Investment Shastra
what is tax-loss harvesting

What is Tax Loss Harvesting?

As an investor, you would be aware that you will be liable to pay tax on the capital gains you have incurred by March 31. There are two ways in which you can reduce your tax bill. One is through a process called “Tax Loss Harvesting” and another by taking advantage of the tax exemption on LTCG. We will discuss both in detail here but first, let’s begin with understanding what is LTCG.

Short-term & Long-term capital gains tax rates

LTCG (Long–term capital gains) apply to profits incurred on investments you have held for more than 1 year and STCG (short-term capital gains) applies to profits on holdings of less than 1 year.

Type of Gain Tax Rate
LTCG up to Rs. 1 lakh 0%
LTCG above Rs. 1 lakh 10%
STCG 15%

As can be seen in the table above, the tax on Long Term Capital Gains in Equity are exempt up to 1 lac for each financial year. This is our first opportunity to save on tax.

Let us understand this with an example. Let’s say you bought 1,000 shares of SBI Ltd for Rs. 400/share in 2020 and sold them for Rs. 500/share in 2022. Since you held those shares for more than a year, your LTCG would be Rs. 1 lac. In this case, you don’t need to pay any tax.

How can you take advantage of this?

In case you haven’t booked any gains this year, but you have unrealized capital gains of up to 1 lac in your account, you can take advantage of this exemption by selling the shares today and realizing the capital gains. You can then buy the same stock again (on the same day in a different Demat account or after 2 days in the same Demat account)

Now, what if you had sold some shares within a year of investment and earned STCGs of Rs. 50,000? You will incur an STCG at a flat rate of 15%. Now, STCGs do not have any exemption and are taxed irrespective of the amount of gain.

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This is where Tax Loss Harvesting comes in

Tax-loss harvesting is the exercise of selling a stock at a loss i.e. below your buy price, in order to convert the notional losses into real losses. This booked loss can then be set off against the capital gains.

Let’s say, you have realized a short-term capital gain of Rs. 2,00,000 so far in this financial year. And you now want to reduce this tax payout. You need to check your account for any short-term unrealized losses and book all those before March 31. Suppose you had Rs. 70,000 unrealized capital loss but want to continue holding it. What you can do is, sell the shares today and buy back them back after a day in a different Demat account or after 2 days in the same Demat account and book a loss of Rs. 70,000. Doing this reduces your taxable gains to Rs. 1,30,000 (2 lac minus 70 thousand). Your tax liability is reduced to Rs 19500 (15% on 1.3 lac) as against the initial liability of Rs 30000 (15% of 2 lac).

There’s a caveat you need to keep in mind though. The long-term capital loss will only be adjusted towards long-term capital gains. However, a short-term capital loss can be set off against both long-term capital gains and short-term capital gains.

Is Tax-Loss Harvesting a method to save Tax?

No, tax loss harvesting is a mere postponement of tax liability and not tax saving. That is because, those gains are going to be realized someday in the future, and will be taxed then. However, it is a very effective way of Tax Deferment.

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Pratik Banthia

Pratik is a CFA Level-2 candidate with an M.Sc. in Finance from NMIMS. Prior to joining MoneyWorks4Me, he briefly worked in sell-side equity research. He is an avid F1 fan and loves filter coffee.