Tax Loss Harvesting

Tax Loss Harvesting: Minimize Tax To Improve Investment Returns

Have you ever thought of getting benefits from a fall in the value of an asset in the portfolio?

Sounds interesting, right.

Well, the answer is Yes.

You can take advantage of the assets whose values are decreasing day by day.

The term is known as tax-loss harvesting. Investors often use tax-loss harvesting to improve stock trading returns.

As honest citizens, paying taxes should be our responsibility so as to ensure the country’s security, progress and well-being.

Actually, no one wants to pay a huge amount of their earnings as income tax. Those, who come under the category of high income, have to pay a huge percentage of tax. For instance, the total tax liability of a salaried person could be around 30% which makes a huge impact on their finances.

Tax-Loss harvesting is the way through which you can increase post-tax returns on investment. With this method, you can maximize wealth aggregation especially at the beginning of the portfolio.

Table of Contents

    1. Understanding Tax Loss Harvesting
    2. Examples of Tax Loss Harvesting
    3. Three Ways to Minimize the Tax

Understanding Tax Loss Harvesting in Simple Terms

To get a brief of tax-loss harvesting and how it helps you minimize your long term capital gains, you need to know how long term capital gain is taxed.

Long term capital gains on equities are re-introduced by the late finance minister Mr Arun Jaitley in 2018.

As per the provision of the financial budget of 2018, any long term gain made from equity investment above 1 Lakh per year is taxable at 10%.

Here, the long term capital gains are the return you make by selling equity investment held for more than 12 months.

If you are a newbie into the stock market or mutual fund, your yearly gain may not necessarily cross the amount of Rs 1 Lakh.

But if you continuously invest and gain share market trading returns, in the long run, you will be in the situation to cross the threshold after some time.

Let’s understand it with an example:

If you invest Rs 5000 per month in equity funds with an average return of 12%, you will easily achieve taxable gains in the span of 2 years.

Here, we present a table where you can see the SIP amount and capital gains with annualized returns of 12 per cent in different periods.

SIP Amount After 24 Months After 36 Months After 48 Months After 60 Months
5,000 15,325 35,396 65,076 1,05,518
8,000 24,520 56,634 1,04,122 1,68,829
12,000 36,780 84,951 1,56,183 2,53,243
15,000 45,945 1,06,189 1,95,229 3,16,554
30,000 91,949 2,12,378 3,90,458 6,33,108

Hence, people who have large equity portfolios will have huge gains. If you want to pay no tax or less tax, make sure these gains should not exceed the tax-free limit. That’s where tax-loss harvesting comes into play.

Tax Loss Harvesting

Tax-loss harvesting is a way of selling a part of your mutual fund units in order to book long term capital gains and start reinvesting the same amount in the same mutual fund.

Still not understand? Let’s take another example:

Example 1

Let’s assume you have invested Rs 6,00,000 in an equity mutual fund on 21 August 2021 and on 31 August, the value of the investment becomes Rs 6,90,000.

Now, if you redeem the investment, your gain will be Rs 90,000 and hence your tax liability will be zero. As the tax has to be paid only if gains exceed the limit of Rs 1 Lakh.

Now, if you reinvest the entire amount i.e Rs 6,90,000 after redeeming in the same mutual fund, it will be counted as a fresh investment along with the date of investment.

If the investment value increases up to Rs 7,50,000 post 1 year. When you redeem the investment amount, your gain will be Rs 60,000 which is less than Rs 1 Lakh.

Had you not redeemed Rs 6,90,000 and reinvested in the same mutual fund, your long term gains would have been up to Rs 1,50,000 and hence, you are required to pay 10% tax on the amount which exceeds Rs 1,00,000.

Now, you have to pay tax for the amount above Rs 1 Lakh. hence, the tax applicable would be Rs 5000 i.e (10% of 50,000).

Still, Confused? Let’s take another example:

Example 2:

Tax-loss harvesting allows you to book losses and use the loss amount to offset capital gains in another instrument in order to minimize liability.

For instance, if you invest Rs 2 Lakh in a fund on 2 August 2021 and on August 15, 2021, your investment value would is Rs 1.85 Lakhs. Hence, your long term capital loss is Rs 15,000.

Now, if you sell the investment instrument, it is obvious you are suffering from losses, but you can use the entire loss amount to offset any long term capital gain in order to bring down tax liability.

For instance, within two years, you sell a long term capital gain and book a profit of Rs 1.5 Lakh. Since the capital gain is above 1 lakh i.e Rs 50,000, you have to pay tax.

Now, you may decrease the total tax applied on Rs 50,000 by subtracting the Rs 15000 from Rs 1.5 Lakh.

Hence, your long-term capital gain will be Rs 1.5 Lakh – Rs 15,000 = Rs 1,35,000. Now you need to pay tax only at Rs 35,000 not on Rs 50,000.

This is how the tax-loss harvesting strategy works. It saves tax for many investors.

Ways of Minimizing Tax Liability

Here are three ways a person can minimize their tax liability:

Tax Planning

Tax planning is a legal method used to minimize tax liability. This can be achieved with proper tax planning. A person can easily minimize tax by taking advantage of many things such as exemptions and deductions.

Tax Avoidance

Many people compare tax avoidance with tax evasion. However, they are different t methods. Tax avoidance is a legal method that helps investors to minimize their taxes. It is the use of smart strategies to reduce a person’s tax liability.

Tax Evasion

Tax evasion is an illegal way of minimizing tax, which is also known as tax fraud. We strongly advise you to stay away from such fraudulent methods.

The Bottom Line

Tax gain and tax loss harvesting are the best ways to minimize the tax you normally pay on equity trading investments. Do remember, you have to reinvest the money as soon as you get the redemption amount in your account.

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