Tax Loss Harvesting – How it Works and Points to Remember

Tax-Loss harvesting is a way to decrease your tax burden on the gains that you may have incurred on your booked profits.

You make capital gains with the profits booked in equity investments (stocks or even mutual funds). These gains are taxable based on how long you remain invested in the – short term capital gains if invested for under a year or long term capital gains if an investment is for over a year.

So one can use Tax-loss harvesting to reduce tax liability on your booked profits.

How does Tax Loss Harvesting work?

Tax-loss harvesting is a way to reduce your tax burden. The way you do tax-loss harvesting is to sell your stocks/fund units that are still not profitable to reduce the tax liability on capital gains.

The capital gain tax applies to the overall gains made in the given fiscal.

You don’t need to pay the tax if you keep holding the profits. Tax is applicable only once you book a profit.

So once you have booked the profit, one can also book some other loss-making investment to offset the overall gain in the given fiscal – this is known as tax-loss harvesting.

There is a dip in the market. So some of your investments in the portfolio may not be profitable anymore.

So, you can sell the non-profitable investment at a higher price and, depending on your view of the company, and you can re-enter at a lower level again.

It means your tax burden reduces because of the booking loss.

Most investors use the strategy at the end of the financial year when they need to file returns. The market always takes a dip in March. However, you can plan to be doing the same in the whole year.

Tax-Loss Harvesting Example

Let me try to explain tax-loss harvesting with the help of an example.

Let’s say we have made a short term capital gain of 2L and LTCG of 5L.

There are stocks in the portfolio making a loss of 50k for the short term holding period.

Beginning from 1 April 2018, an LTCG of more than Rs 1 lakh will be taxed 10%. STCG is flat 15%.

Now, if I don’t sell my loss making position, my tax amount is

Tax payable = [STCG(Rs 200,000 x 15%)+{LTCG(500,000-100,000) x 10%}] = Rs 70,000.

Now, if I book the loss of the 50k in my short-term holding portfolio, the tax amount is

Tax payable = [STCG(Rs 150,000 x 15%)+{LTCG(500,000-100,000) x 10%}] = Rs 62,500.

We save a tax of ₹7500, aka 50,000 x 15%.

Again, if you want to keep holding the stock that you sold at a loss, you can purchase them back the next day.

Remember, if you buy it on the same day, you will not be booking a loss because it will be termed day trading.

So the gains or losses made by day trading doesn’t get into the LTCG or STCG, but they are part of speculation gain or loss.

So, ideally, you should be buying the stock the next day. Ideally, I prefer to buy the day after my CDSL DP debits the stock units. So it is after t+2, so I buy them on the t+3 day.

Few Points to Remember

Remember that long-term capital losses can be offset against only long-term capital gains. So, you can’t set off long-term capital loss against short term capital gains.

However, short-term capital losses can be offset against short-term capital gains or long-term capital gains.

So ideally, people use the demat and brokerage expenses to set off against short term capital gains.

Final Thoughts

I am not a tax expert. You should consult your tax expert and then only take any action.

However, I am sharing the concept to know what you should be asking your tax man. Secondly, the tax-loss harvesting concept can help you book losses on investments that are not worth holding.