• HDFC securities
• 27 Mar 2023
• Knowledge Centre

 

 

When you invest in any financial security, there is always a risk of loss as not all investments will be profitable. However, the loss incurred on a certain investment can be put to your advantage. It can be useful in lowering your tax liability. This strategy is known as tax loss harvesting. Let us understand tax harvesting meaning in detail.

Tax loss harvesting is a strategy that is used to reduce your tax liability on selling a profitable investment. It is a practice of selling loss-bearing securities to help offset taxes on any capital gains income from selling profitable assets. This is done by harvesting the loss.

Tax loss harvesting can be employed for both Short-Term and Long-Term Capital Gains. However, maximum investors prefer employing it for short-term capital gains as it is taxed at a higher tax.

In the tax loss harvesting process, you sell an investment which is incurring you a loss. This loss can be used to reduce your taxable capital gains and offset against the capital gains made on selling another investment at profit. Then the proceeds from the sale of the loss-making security can be reinvested to purchase similar security to maintain the portfolio’s asset mix.

How does tax loss harvesting work?

Here’s a simple example to explain the working of tax loss harvesting better.

Let’s assume you made Short-term Capital Gains (STCG) of Rs 2,00,000, Long-Term Capital Gains (LTCG) of Rs 2,50,000 and short-term capital loss worth Rs 50,000 on various equity investments during a financial year.

Suppose you do not opt for tax-loss harvesting. Your tax liability will be as follows:

> STCG Tax = 15% of 2,00,000 = 30,000

> LTCG Tax = 10% of 2,50,000 = 25,000

> Total tax liability = 30,000 + 25,000 = 55,000

By using the tax-loss harvesting strategy to calculate the tax payable for the financial year, you can offset the amount of short-term capital loss against the short-term capital gains. Hence, the tax liability on STCG will be calculated at Rs 2,00,000 – Rs 50,000, which is Rs 1,50,000.

> STCG Tax = 15% of (2,00,000 - 50,000)
                      = 15% of 1,50,000
                      = Rs 22,500  

> LTCG Tax = 10% of 2,50,000 = 25,000

> Total tax liability = 22,500 + 25,000 = 47,500

 

Besides, saving on taxes, tax loss harvesting can help you optimise your investment portfolio better. You can sell your loss-making investments and use the sale proceeds to buy other lucrative investments. This will help you earn better returns.

What to be mindful of with tax loss harvesting?

Now that you are well aware of tax harvesting meaning, the following are some pointers you should be mindful of:

• You can set off Short-Term Capital losses against Short-Term Capital Gains or Long-Term Capital Gains.
• You can set off Long-Term Capital losses only against Long-Term Capital Gains.
• Though tax-loss harvesting is a useful tool you must not base your investment decisions entirely on it. If you think your investment will generate good returns in the long run and fits right in your investment strategy, then continue to hold it.