What is Tax Harvesting?

Tax harvesting is selling underperforming investments at a loss to offset the capital gains by selling other investments at a profit. Consequently, your tax burden is lowered since you only pay taxes on your net profit, which is the difference between your gains and losses.

Many investors favor eliminating or minimizing their capital gains tax. Tax harvesting is one of the processes which can accomplish this. This article defines tax harvesting's meaning and explains how it can increase your returns.

Taxes can be reduced by Tax harvesting by utilizing losses in one security to offset profits in another. Although the current tax code permits investors to cover the shortfall in one investment with profits in another, it does not help you to use losses to protect future gains.

It enables you to sell an investment that has suffered a loss and reinvest the proceeds in the same or a different asset. It can help you balance your portfolio by allowing you to realize a gain on an investment that has performed well while balancing a loss on a security that has executed poorly.

It is a method that needs you to pay more attention to the market, but this could be advantageous because it enables you to capitalize on market swings and make more informed investing selections.

For investors that invest in equity funds, the tax rate on Short-Term Capital Gains might be as high as 15%. Short-Term Capital Gains are profits from selling a capital asset held for less than a year. Long-Term Capital Gains are profited from the sale of capital assets held for more than a year and are taxed at a rate of 10%. Long-term capital gains up to Rs. 1 lakh are exempt from taxation.

This can eat into an investor's profits especially in the case of short term investments. However, Tax-loss Harvesting is a method for reducing the taxes on this type of capital gain.

To know the concepts if financial year and assessment year better and understand their importance to a tax payer, let’s consider an illustrative example.

For the Financial Year that started on 1st April 2021 and ended 31st March 2022 i.e. FY 2021-22, the applicable Assessment Year started on 1st April 2022 and ended on 31st March 2023 i.e. AY 2022-23. So, if you choose the wrong AY while filing returns, your ITR filing will be rejected by tax authorities.

This means if you select AY 2021-22 at the time of filing ITR, you will be filing income tax returns for the FY 1st April 2020-31st March 2021, and not for 1st April 2021-31st March 2022.

To further comprehend the effect of the technique, let's examine two scenarios: one without the method and one with tax loss harvesting.

For instance, your portfolio contains four shares of businesses A, B, C, and D that you purchased on January 2 for Rs. 400, Rs. 800, Rs. 1200, and Rs. 500 for a total principal capital investment of Rs.

• Stock A- Rs. 400
• Stock B- Rs. 800
• Stock C- Rs. 1200
• Stock D- Rs.500

On April 20th, you discover that company A's stock price has constantly decreased while the prices of other stocks have increased. Currently, stock prices are at

• Stock A- Rs. 150
• Stock B- Rs. 900
• Stock C- Rs. 1300
• Stock D- Rs.700

Now is the time to sell stock A and record the losses. Then, you can do two things with the proceeds: after two days, you can purchase further shares of firm A. Second, buying shares of a different company within the same sector or with a comparable business. Or, if you believe the price decline will likely halt, you can choose to keep the stock./p>

We will examine how tax loss harvesting impacts both scenarios, where losses are booked and when they are not.

Let us assume, for the sake of calculating simplicity, that you did not sell stock A. In the end of the financial year, you found the stock price to be

• Stock A- Rs.600
• Stock B- Rs. 1,000
• Stock C- Rs. 1400
• Stock D- Rs. 900

Now, your net profits or short-term capital gains (STCG) for the year total more than 200 rupees.

• 200+Rs.
• 200+Rs.400=Rs.1000.

Before you decide to sell under-performing investments in order to benefit from tax loss harvesting, do keep the following in mind:

• Short-term gains cannot offset long-term losses.
• Before making any trades that result in a loss, an investor should assess their tax liability as per applicable income tax slab and capital gains tax rules.
• Before investing in the released funds, an investor must evaluate the risk-reward profile of an asset.
• The technique should only be utilized for tax savings. It should not influence investing decisions.

Tax loss harvesting is a fundamental idea that reduces the tax burden resulting from short-term and long-term investment profits. However, the strategy should only be used for tax planning and not be employed as a portfolio management tactic since its frequent use may amplify losses.

Annually, you should consider harvesting tax losses based on your tax and financial status. As with most financial and tax methods, it is not ideal for everyone or even every year, so it is essential to assess the pros and downsides and remain focused on your circumstances.

This preceding example is merely a simplistic illustration with minimal theoretical amounts provided for clarity. In the actual world of investing, however, this tax-saving method can save you significantly more money and help you rationalize your capital gains. In addition, it enables you to protect your profits and reduce tax liability by simply offsetting capital losses against investment gains in the case of redemption.