Among all tax-saving strategies, the one that consistently intrigues and confuses investors is how to save tax through tax-loss harvesting.
Whether the markets have taken a dip or certain assets in your portfolio have underperformed, tax-loss harvesting lets you use those losses to your advantage. Let’s understand how exactly it works and how to leverage it.
Understanding the Basics of Tax Loss Harvesting in India
Tax Loss Harvesting is a strategy where you as an investor can sell your loss-making investments to offset capital gains from your profitable investments. The main aim is to reduce their overall tax liability.
You can set off both short and long term capital losses, but it’s important to understand:
- Short-term capital losses (STCL) can be set off against both short-term and long-term capital gains.
- Long-term capital losses (LTCL) can only be set off against long-term capital gains.
If you are unable to fully set off losses in the current year, they can be carried forward for up to 8 years, provided they are declared in the income tax return.
After selling a loss-making investment, you can repurchase the same securities without facing penalties.
How to Save Tax Through Tax-Loss Harvesting: Steps to Implement
In order to set off your losses, you need to go through the following steps:
1. Review Your Portfolio
Analyze your investments to identify those that have declined in value since purchase and are unlikely to recover soon. These are the most likely candidates for tax-loss harvesting.
Separate short-term and long-term investments based on their holding period.
2. Assess Gains and Losses
Estimate your capital gains for the financial year.
Categorize them as short-term capital gains (STCG) or long-term capital gains (LTCG).
In India, short-term capital gains apply to assets held for one year or less, while long-term capital gains apply to assets held for over one year (two years in case of non-equity).
3. Sell Loss-Making Assets
Sell the investments that have incurred losses, to realize the capital loss before the end of the financial year
This can now be used to offset the gains.
4. Offset Capital Gains
Use the realized losses to offset any capital gains from other investments. This reduction can lead to substantial tax savings.
For example, if you have INR 1,00,000 in gains and INR 50,000 in losses, your taxable gain reduces to INR 50,000.
5. Reinvest Strategically
After selling the loss-making investments, you can reinvest in similar assets or different assets that align with your financial goals.
Before making such investments, make sure you consider your risk taking ability and future long term and short term goals.
Although the wash sale rules do not apply in India, we at PKC Management Consulting, recommend waiting for 30 days or more, or reinvesting in similar (but not identical) assets.
6. Document Transactions
Maintain detailed records of all transactions related to tax-loss harvesting. This includes purchase dates, sale dates, and amounts for each asset.
This is important for accurate reporting during tax filing.
7. File ITR Properly
Declare both the gains and losses in your tax return. Ensure that you utilize the losses to reduce your taxable capital gains.
Use Form ITR-2 for reporting capital gains.
Remember, you can setoff or carry forward losses only when ITR is filed
8. Future Carry Forward:
If your total capital losses exceed your gains, you can carry forward these losses for up to eight assessment years.
However, make sure it is reported in the current year’s income tax return.
Top Tips & Mistakes to Avoid While Tax Loss Harvesting
Tips for Maximizing Benefits of Tax-Loss Harvesting
- Timing is important: Consider harvesting losses towards the end of the financial year. This gives you a clearer picture of your overall gains and losses.
- Focus on short-term losses first: Short-term capital gains are taxed at a higher rate. Prioritize offsetting these with short-term capital losses.
- Avoid repurchasing similar assets: While India doesn’t have a formal wash sale rule, be cautious about immediately repurchasing the exact same security. Consider alternatives that maintain your investment strategy without being identical.
- Seek Professional Advice: Tax laws can be complex, so consulting with a tax expert or financial planner can help you navigate the process and avoid costly mistakes.
- Utilize index funds or ETFs: These can help you maintain market exposure while harvesting losses from individual stocks.
- Consider tax-loss harvesting throughout the year: Don’t wait for year-end; look for opportunities during market downturns
- Balance tax savings with investment goals: Don’t let tax considerations override sound investment decisions. Ensure your portfolio remains aligned with your long-term objectives.
- Keep an eye on transaction costs: Factor in brokerage fees when calculating potential tax savings.
- Carry forward unused losses: Remember, you can carry forward capital losses for up to 8 years in India. Keep meticulous records to utilize these in future years
- Coordinate with other tax-saving strategies: Integrate tax-loss harvesting with other methods like tax-efficient fund placement
Common Mistakes to Avoid During Tax-Loss Harvesting
- Ignoring the entire portfolio: Focusing solely on underperforming assets can lead to missed opportunities. Regularly review your entire portfolio for potential tax-loss harvesting options.
- Not considering the bigger picture: Selling investments solely for tax purposes without considering long-term financial goals can have a negative impact on your earnings overall.
- Overlooking transaction costs: Failing to factor in brokerage fees and other transaction costs. It is unwise to harvest losses that are smaller than the cost to execute the trades.
- Poor timing: Waiting until the end of the financial year to harvest losses. This may lead to missed opportunities during market downturns throughout the year.
- Improper record-keeping: Failing to maintain detailed records of purchase dates, sale dates, and amounts. It can lead to incorrect reporting of losses on tax returns
- Mismatching losses and gains: Attempting to offset short-term gains with long-term losses. Not utilizing the full potential of short-term losses to offset both types of gains
Frequently Asked Questions
- Does tax loss harvesting reduce taxable income?
Yes, tax-loss harvesting can reduce taxable income by offsetting capital gains with realized capital losses. This means that if you sell investments at a loss, those losses can be used to lower the amount of taxable gains, thereby reducing your overall tax liability for the year.
- Is tax loss harvesting worth it in India?
Yes, tax-loss harvesting can be beneficial in India, especially for investors with significant short-term capital gains, as it allows them to reduce their tax burden. By selling loss-making investments, investors can offset their gains and save on taxes.
- What are the disadvantages of tax harvesting?
Some disadvantages include complexity in managing investments and understanding tax implications of the strategy in the short term and long term.
- What is the last date for tax loss harvesting?
In India, there is no specific “last date” for tax-loss harvesting; however, it we recommend you execute any sales before the end of the financial year (March 31) to ensure that losses are recognized in that assessment year.
- Can you carry over tax loss harvesting?
Yes, if your capital losses exceed your capital gains in a given year, you can carry forward the remaining losses to offset future capital gains in subsequent years. In India, capital losses can be carried forward for up to eight assessment years.
