Tax loss harvesting: What is it and how does it work?4 min read
No investor or trader would want to pay more taxes than required on their investments.
There are a few ways to minimize the tax outgo on gains made in the stock market. One such tool is tax loss harvesting, which can help reduce the tax liability on short-term capital gains (STCG) and long-term capital gains (LTCG).
Tax loss harvesting is usually done towards the end of the financial year, but can of course be done throughout the year to lower the capital gains.
What is tax loss harvesting?
The idea is simpler than it sounds.
Tax loss harvesting is the concept of selling securities or fund units at a loss to lower the tax liability on capital gains. This means that losses from sale of one stock can offset the taxes on profit from another stock, by lowering the total capital gains.
So if an investor has made losses from a stock, this is one strategy to take advantage of the situation by reducing the overall capital gains, and consequently reduce the tax to be paid.
The current tax rate on STCG in a fiscal year is 15%. Since April 1 2018, the tax rate on LTCG of over Rs 1 lakh is 10%. Profit on securities held for over a year is considered as LTCG.
Tax loss harvesting is usually done to lower STCG, since the tax rate is higher.
Do note that long-term capital losses can be offset against only long-term capital gains. However, short-term capital losses can be set-off against either STCG or LTCG.
After shares sold are moved out of the demat account, the investor has the option of repurchasing them the next day.
To make use of tax loss harvesting before the current financial year ends, you have the option of selling your loss-making holdings till March 31, 2022.
Losses booked on shares sold after March 31, 2022 will not be considered. The same applies for the end of each financial year.
How to download P&L Statements on Paytm Money:
- Go to : https://www.paytmmoney.com/stocks/profile/statements > P&L
- On the Mobile App, Go to Stocks Dashboard > Account Section > Statements > P&L
FIFO
We have already understood that stocks have to be sold in a loss to save on taxes by offsetting against the profits we have made.
To book on loss making trades, you also have to keep in mind the underlying FIFO principles i.e. when selling a stock, whether or not the transaction will make a loss depends solely on which shares will be sold and the buy price of those shares.
Let’s take a look at a few scenarios.
Example 1
Let’s say your portfolio has generated STCG of Rs 70,000 and LTCG of Rs 1.1 lakh, but you have an unrealised short-term capital loss of Rs 30,000.
Tax liability (without harvesting)
On STCG: 15% * 70,000 = Rs 10,500
On LTCG: 10% * (Rs 1,10,000 – Rs 1,00,000) = Rs 1,000
Total tax due = Rs 11,500
Tax liability (with harvesting)
On STCG: 15% of Rs 40,000 (Rs 70,000 – Rs 30,000) = Rs 6,000
On LTCG: Rs 1,000 (as shown above)
Total tax due = Rs 7,000
This means that the tax liability is reduced by Rs 4,500.
Example 2
Let’s take a look at a hypothetical portfolio and see how this would work.
The investor has made STCG of Rs 1,18,151.1 by selling stock in Infosys & State Bank of India, which they held for less than a year.
Without harvesting, the tax liability is 15% of Rs 1,18,151.1 = Rs 17,722.
However, if the investor chooses to sell the shares that are making losses, then the STCL is Rs 51,593 So the STCG is now Rs 118151.1 – Rs 51,593 – Rs 66,558.
With harvesting, the tax will 15% of Rs 66,558 = Rs 9,983
So the tax saved is Rs 7,779!
Conclusion
Tax loss harvesting will not eliminate your tax liability, but will help minimise it. An investor/trader can use the proceeds to invest in another stock or mutual fund, in order to maintain the optimum asset allocation.
Disclaimer: This content is purely for educational, information and investor awareness purposes based on publicly available data and in no way to be considered as advice or recommendation. The securities quoted are exemplary and are not recommendatory. Representations made about the performance are not indicative of future results. Please refer www.paytmmoney.com for further information.
