Tax Loss Harvesting: A Guide to Reducing Your Taxes Through Smart Planning

When you invest in equity funds, the returns you earn may be subject to capital gains tax, depending on how long you hold the investment. One effective way to reduce this tax burden is through tax loss harvesting. This strategy involves offsetting your investment gains with losses, helping to lower your taxable income and maximise wealth over time. While this approach may seem indirect, it can be an effective tool for anyone aiming to grow their portfolio.

What is Tax Harvesting’s Meaning?

Tax harvesting in mutual funds is a strategy that involves selling investments that have suffered a loss to offset capital gains from other investments. The goal is to minimise your tax liability by balancing the gains you made with the losses you've incurred. This approach effectively reduces both short-term and long-term capital gains taxes.

How does Tax Loss Harvest Work?

Let’s say you’ve invested in Stock A and Stock B.

Stock A has performed well, giving you a short-term capital gain of Rs 50,000. However, 

Stock B has underperformed, resulting in a loss of Rs 30,000.

Here’s how the taxation would look-

Without tax loss harvesting

The short-term capital gain from Stock A is Rs 50,000.

With the STCG tax on equity funds at 20%, your tax liability would be Rs 10,000 (Rs 50,000 * 20%).

With tax loss harvesting

The short-term capital gain from Stock A is Rs 50,000, and the loss from Stock B is Rs 30,000. This results in a net gain of Rs 20,000.

Now, the tax will be applicable on the net gain of Rs 20,000, resulting in a tax of Rs 4,000.

By applying the tax loss harvesting strategy, you have reduced your tax liability from Rs 10,000 to Rs 4,000, saving Rs 6,000.

Benefits of Tax Loss Harvesting

Here are the advantages of tax loss harvesting-

1. Defer capital gains taxes- Selling investments at a loss allows taxpayers to defer capital gains taxes, which is especially beneficial for long-term investments, giving more time for compounding.

2. Better portfolio management- By using losses to offset gains from highly taxed assets, you can reduce your tax burden while keeping your portfolio balanced.

3. Boost returns- Offsetting short-term gains with losses lowers immediate tax payments. Moving to long-term investments also means paying lower tax rates, which improves overall returns.

Things to Keep in mind while Tax Loss Harvesting

While tax loss harvesting sounds like a great way to save money, there are a few factors to keep in mind-

1. Wash sale rule

A wash sale occurs when you sell underperforming assets and repurchase the same investment within 30 days before or after the sale. In this case, you cannot claim the loss for tax purposes. This rule prevents investors from artificially creating losses for tax benefits.

2. Applicability

Long-term capital losses can be used only to offset long-term capital gains, whereas short-term capital losses can offset both long-term and short-term capital gains.

3. Expert advice

It’s always wise to consult a tax advisor or financial planner before executing tax loss harvesting, as the rules can be complex. They can help you better understand this strategy.

How does Tax Loss Harvesting Apply to Mutual Funds?

You can also apply tax harvesting to your mutual fund investments, just like you would with stocks. Here's an example to help explain.

Suppose your portfolio includes both equity and debt mutual funds. One of your equity funds, Fund A, has underperformed, and its value has dropped below its benchmark index. To minimise your tax liability, you decide to sell Fund AA at a loss. This realised loss can then be used to offset capital gains taxes from other profitable investments, such as-

Other equity mutual funds

Individual stocks’

This approach helps reduce your tax burden while optimising your portfolio for future gains. Tax harvesting with mutual funds is a smart way to manage taxes and improve overall investment returns.

Wrapping up

Tax loss harvesting is a powerful strategy that reduces your tax liability and helps your investments grow. By offsetting your capital gains with losses, you keep more of your wealth and improve your financial position.

FAQs

What is tax-loss harvesting?

Tax-loss harvesting means selling investments at a loss to reduce taxes on profits from other investments. It helps lower your taxable income and can be an effective way to manage your portfolio.

What is the 30-day rule for tax-loss harvesting?

India doesn’t have a formal 30-day rule. To avoid issues, wait 30 days before buying the same investment again after selling it at a loss for tax purposes.

Is tax-loss harvesting good or bad?

Tax-loss harvesting is beneficial when done correctly. It lowers taxes and improves returns, but proper planning is required to avoid disrupting long-term investment goals.

Do you pay taxes on stocks if you sell at a loss?

No, selling stocks at a loss doesn’t attract taxes. Instead, these losses can offset profits or be carried forward to reduce future taxable income, lowering your overall tax liability.