As the financial year draws to a close, many investors will be reviewing their portfolio for realized / unrealized profit & loss and planning for the future. In addition to reviewing and adjusting the portfolio, an investor can also adopt a tax saving strategy called “Tax Loss Harvesting” to help reduce Capital Gain Tax.
What is Tax Loss Harvesting (TLH)?
Tax Loss Harvesting is the practice of selling securities with unrealized loss to offset capital gain tax liability. The sold securities are then replaced by similar securities to maintain the level of asset allocation at optimal level. Tax loss harvesting could be done in case of shares & Equity Mutual funds.
Before understanding tax loss harvesting with an example, let us know the capital gains tax rates in case of equity shares.
Prior to April 2018, the long term capital gains (LTCG) made on sale of equity shares were tax-free. However, in the Union budget for 2018-19 LTCG was introduced. Beginning April 01, 2018, LTCG made in excess of 1 lac will be taxed @ of 10%. Short term capital gains (STCG) are taxed @ 15%.
Depending upon the holding period of the securities the capital gain is classified into LTCG and STCG. If the security (stocks and equity MF) is held for a period of more than one year it is LTCG, if the security is held for less than one year it is STCG.
Example of Tax Loss Harvesting
Mr. Joshi has a portfolio consisting a mix of stocks bought at different time intervals.
Stock A – Held for 15 months & has an unrealized gain of Rs 20,000
Stock B – Held for 20 months & has an unrealized loss of Rs 50,000
Stock C – Held for 7 months & has an unrealized loss of Rs 7,000
Mr. Joshi out of his portfolio has sold two stocks to meet some urgent financial needs
Stock E – Held for 20 months & sold at a gain of Rs 1,30,000
Stock F – Held for 10 months & sold at a gain of Rs 45,000
- Capital gain tax payable without tax loss harvesting:On stock E, he will be taxed LTCG @10%, since the MF has been held for more than one year. (1,30,000 *10%) = Rs 13,000On stock F, he will be taxed STCG @15%, since the MF has been held for less than one year. (45,000*15%) =Rs 6,750So, the total capital gains tax without tax harvesting will be 13,000 + 6,750 = Rs 19,750
- Capital gain tax payable with tax loss harvesting:
Mr. Joshi will sell stocks B & C which are in loss to offset the gain made by selling stocks E & FLTCG will be (1,30,000 – 50,000) * 10% = Rs 8,000STCG will be (45,000 – 7,000) * 15% = Rs 5,700
Total Capital gains tax paid with tax harvesting is (8,000 + 5, 700 ) = Rs 13,700With tax harvesting opportunity, Mr. Joshi has paid (19,750 – 13,700) = Rs 6,050 less tax.
Thus, the idea of tax harvesting is to reduce the capital gains tax by selling loss making assets to offset capital gain tax liability. Further, the proceeds he has received by selling loss making stocks (B & C) could be reinvested in similar assets he sold for tax harvesting.
By, tax harvesting he has reduced his tax liability and at the same time maintained optimal asset allocation.
Points to remember:
- Long term capital losses can be off-set against long-term capital gains only. You cannot off-set long-term capital losses against short-term capital gains.
- Short-term capital losses can be off-set against either short-term capital gains or long-term capital gains.
To check the Tax Loss Harvesting opportunity in your account, kindly refer to the TLH report available in BOX Back office > Report >Tax P&L.