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Tax Loss Harvesting: What is it and how you can reduce Income Tax liability? Check calculation

Tax Loss Harvesting Calculation, Benefits, How to Reduce Tax Liability by Tax Harvesting Method – Explained by Experts

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Tax Loss Harvesting Calculation: Investors make capital gains or losses whenever they sell their investments in stocks or mutual funds. Capital gains are taxed based on the holding period of your investment. Experts say that investors can reduce their tax liability to some extent by using the tax loss harvesting method. 

According to experts, tax harvesting is one of the most effective ways to reduce tax liability. Read on to find out what it is and how to benefit from this: 

“Tax-Loss Harvesting is a method by which one can reduce the tax incidence on their trading gain. The effect of tax loss harvesting is seen at the portfolio level. Suppose during a year a trader has taken many trades and is sitting on a hefty profit. At the end of the year, he will have to pay a tax on his profits, either long term (held for more than a year) or short term,” Vikas Singhania, CEO of online trading platform TradeSmart told FE Online.

Tax loss harvesting is mostly done to lower the payment of short term capital gains tax.

“However, if the trader is holding on to some trades which are showing a loss, he can book those losses and adjust them against the profits booked on other traders. You are basically offsetting the capital gains against the capital loss. Doing this would reduce your tax liability on capital gains. Lower tax outgo helps improve the return on capital for the trader,” said Singhania. Read on to find out how it can be done: 

What is tax-loss harvesting?

“Tax-loss harvesting is a method to offset the gains from sale of stocks or redemption of mutual funds against the capital loss, and pay a income tax on the net gains. For tax-loss harvesting you have to sell your stocks/fund units at a loss so as to reduce your tax liability on capital gains,” said Archit Gupta, founder and CEO of tax and financial services software platform Clear (formerly ClearTax).

From 1 April 2018, LTCG above Rs 1 lakh is taxed at the rate of 10% without indexation. In comparison, short-term capital gains (STCG) are taxed at the rate of 15%.

How tax loss harvesting works

Gupta said that investors can use this method throughout the year in a planned manner to keep your capital gains at a relatively lower level. 

“You can start with the sale of the stock or an equity fund which are consistently declining in price, the security has lost most of its value, and chances of a rebound are bleak. Once the loss is realised, you can offset the loss amount against capital gains that your portfolio has earned over the period,” he said.

Tax Loss Harvesting: Calculation

Suppose in a given financial year your portfolio made an STCG and LTCG of Rs 1,00,000 and Rs 1,05,000 respectively. The short-term capital losses were Rs 50,000.

Tax payable (Without tax loss harvesting) [(STCG * 15%)+{(LTCG-100,000)*10%}]

[(Rs 100,000 * 15%)+{(105,000-100,000)*10%}] = Rs 15,500

Tax payable (With tax loss harvesting) = [(STCG-STCL * 15%)+{(LTCG – 100,000) * 10%}]

[{(Rs 100,000-Rs 50,000) * 15%)}+{(105,000 – 100,000) * 10%}] = Rs 8,000

So, as you can see from the above example, tax liability can be significantly reduced by tax loss harvesting. 

Tax Loss Harvesting Benefits 

According to Gupta, the amount realised from the sale of the loss-making stock/equity fund can be used to buy a lucrative stock/equity fund. This kind of replacement is necessary to maintain the original asset allocation of the portfolio.

“Moreover, it keeps the portfolio’s risk-return profile intact. Among other measures, tax-loss harvesting is a vital tool to save a lot on taxes. Additionally, you get to know ways to diversify your portfolio to earn higher returns. It doesn’t help to nullify the losses, but it can reduce your suffering by helping you save taxes,” he said. 

Tax Harvesting: What to keep in mind

Experts say that income tax rules must be complied while using tax loss harvesting method. While setting off losses using tax-loss harvesting, you need to keep the following points in mind:

  • Long-term capital losses can be set-off against only long-term capital gains. You cannot set-off long-term capital losses against short-term capital gains.
  • Short-term capital losses can be set-off against either short-term capital gains or long-term capital gains.

“You can see market crash as an opportunity to reduce your income tax liability using tax-loss harvesting,” says Gupta.

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