What Is Tax Loss Harvesting?

Tax loss harvesting is a strategy that allows investors to reduce their taxable capital gains by selling loss-making investments. By utilizing this method, investors can offset their capital gains with the capital losses they incur, resulting in lower tax liabilities. Although it is more commonly discussed in global markets, tax loss harvesting has also gained attention in India due to its ability to optimize tax savings for investors.

This blog provides a detailed guide on tax loss harvesting in India, explaining how it works, the tax implications, and how you can use it to reduce your capital gains tax burden.

What Is Tax Loss Harvesting?

Tax loss harvesting is the practice of selling securities or assets that have incurred a loss to offset taxable capital gains from other profitable investments. This strategy helps investors reduce their overall capital gains tax liability while maintaining their investment portfolios by potentially reinvesting in similar securities.

There are two main types of capital losses that can be used for tax loss harvesting:

Short-Term Capital Loss (STCL): Arises when an asset held for up to 12 months (for equities and mutual funds) is sold at a loss.
Long-Term Capital Loss (LTCL): Arises when an asset held for more than 12 months (for equities and mutual funds) is sold at a loss.

How Does Tax Loss Harvesting Work?

The concept of tax loss harvesting is simple: sell loss-making investments, offset those losses against your gains, and reduce your overall tax liability.

For example, let’s assume you made a profit of ₹2,00,000 by selling shares in one company but incurred a loss of ₹50,000 from another investment. By selling the loss-making investment, you can offset the loss against your capital gains. The net capital gain would now be ₹1,50,000, and you would only pay tax on that amount.

Particulars	Amount (₹)
Capital Gains from Profitable Shares	2,00,000
Capital Loss from Loss-Making Shares	(50,000)
Net Taxable Capital Gains	1,50,000

By harvesting your capital loss of ₹50,000, you reduced your taxable capital gains, resulting in tax savings.

Capital Gains Tax in India: Short-Term vs. Long-Term

Before diving deeper into tax loss harvesting, it’s important to understand the tax rates on capital gains in India.

Type of Capital Gain	Applicable Tax Rate
Short-Term Capital Gains (STCG)	15% (for listed equities and equity-oriented mutual funds)
Long-Term Capital Gains (LTCG)	10% (on gains exceeding ₹1 lakh for listed equities and equity-oriented mutual funds)

The tax rates differ based on the holding period of the asset, with short-term gains taxed at a higher rate than long-term gains. Tax loss harvesting becomes crucial in minimizing the impact of these taxes.

Rules for Offsetting Losses Under Income Tax Act

In India, the Income Tax Act allows investors to set off their capital losses against capital gains. Here’s how you can set off your losses:

Short-Term Capital Loss (STCL): Can be set off against both short-term capital gains (STCG) and long-term capital gains (LTCG).
Long-Term Capital Loss (LTCL): Can only be set off against long-term capital gains (LTCG). It cannot be set off against short-term gains.

Any unadjusted capital losses can be carried forward for up to 8 years to set off against future gains. However, you must file your income tax return within the due date to claim this benefit.

Example of Tax Loss Harvesting

Let’s explore an example where an investor utilizes tax loss harvesting to minimize taxes:

Scenario:

Mr. B has made the following investments during the financial year:

Capital gain from mutual funds: ₹1,50,000 (long-term)
Capital gain from stocks: ₹75,000 (short-term)
Capital loss from real estate: ₹2,00,000 (long-term)

Here’s how Mr. B can apply tax loss harvesting:

Mr. B can set off the long-term capital loss of ₹2,00,000 against his long-term capital gain of ₹1,50,000 from mutual funds, reducing the taxable long-term gain to zero.
The unadjusted capital loss of ₹50,000 (₹2,00,000 – ₹1,50,000) can be carried forward for the next 8 years to offset future long-term capital gains.

Step-by-Step Guide to Tax Loss Harvesting

If you’re considering using tax loss harvesting to lower your capital gains tax, here’s a step-by-step guide to help you through the process:

1. Review Your Investment Portfolio

Start by analyzing your investment portfolio to identify any securities or assets that are currently trading at a loss. This can include stocks, mutual funds, real estate, or any other capital assets.

2. Calculate Capital Gains

Calculate your capital gains for the financial year to understand your tax liability. Identify the gains from both short-term and long-term investments, as they will be taxed differently.

3. Match Losses to Gains

After identifying your loss-making investments, determine which losses can be harvested to offset your capital gains. Use short-term losses to offset both short-term and long-term gains, while long-term losses can only be set off against long-term gains.

4. Reinvest Smartly

Once you’ve harvested your losses by selling the underperforming assets, consider reinvesting the proceeds into similar securities to maintain your portfolio’s asset allocation and investment strategy. However, be mindful of potential wash-sale rules, which might restrict you from buying back the same stock immediately after selling it for a loss.

5. File Your Income Tax Return

Ensure you file your income tax return within the due date to claim the set-off and carry-forward benefits. Use Schedule CG in your income tax return to report capital gains and losses.

Pros and Cons of Tax Loss Harvesting

Like any financial strategy, tax loss harvesting has its pros and cons. Let’s take a look:

Pros:

Tax Savings: Reduces your taxable capital gains and lowers your tax liability.
Portfolio Rebalancing: Allows you to sell underperforming investments and reinvest in assets aligned with your long-term goals.
Carry Forward Benefits: Unadjusted losses can be carried forward for up to 8 years, providing future tax-saving opportunities.

Cons:

Potential Market Timing Risks: By selling loss-making assets, you might miss out on future market recovery or gains if the asset rebounds after the sale.
Reinvestment Risks: Reinvesting in similar assets might expose you to the same risks that led to the initial losses.

Historical Data: Capital Gains Tax and Tax Loss Harvesting in India

Year	Capital Gains Tax Rate (LTCG on Equities)	STCG Tax Rate
2022	10% (on gains over ₹1 lakh)	15%
2018	10% (on gains over ₹1 lakh)	15%
2014	Nil	15%
2010	Nil	15%

The introduction of the LTCG tax on equities in 2018 has made tax loss harvesting an increasingly important strategy for Indian investors to reduce their tax liabilities.

Tax Loss Harvesting vs. Long-Term Investment

While tax loss harvesting can be an effective strategy to reduce taxes, it’s important not to lose sight of your long-term investment goals. Here are a few considerations:

Investment Horizon: If you’re a long-term investor, selling loss-making investments solely for tax benefits might not always be the best decision. Consider whether the asset has the potential for recovery.
Rebalancing vs. Tax Harvesting: Tax loss harvesting can help with portfolio rebalancing, but avoid frequent trading or timing the market, as this can lead to higher transaction costs and increased risk.

Conclusion

Tax loss harvesting is a powerful tool that can help investors reduce their capital gains tax and maximize their returns in the long run. By strategically selling loss-making investments and offsetting them against profitable gains, investors can achieve significant tax savings while maintaining a balanced portfolio.

However, it’s essential to approach tax loss harvesting carefully. Make sure you’re mindful of potential market risks and long-term investment goals before implementing this strategy.

By following the steps and tips outlined in this guide, you can make the most of tax loss harvesting and optimize your tax planning for the financial year.