21 March 2024 | By INDIE
We generally use our investment portfolio to supplement our income from salary and create wealth over time. But paying taxes on capital gains can be such a pain!
Did you know that you can use the concept of tax loss harvesting to reduce your capital gains tax liability?
Let’s find out how!
Tax loss harvesting is a method that involves selling underperforming stocks in your investment portfolio to offset capital gains and lower your tax liability. This allows you to increase your portfolio's tax-adjusted returns.
Example: If you earn ₹2 lakh in Short-Term Capital Gains (STCG) this year, you must pay 15% as taxes, which amounts to ₹30,000.
But, if you hold stocks with an unrealised loss of ₹1.2 lakh, you can sell it to reduce your net STCG to ₹80,000. This means you’d have to pay 15% of ₹80,000, which amounts to ₹12,000 in taxes. You can effectively save ₹18,000 in taxes!
Please note, however, that you should not factor your investment decisions solely based on tax loss harvesting. Consider other factors like investment goals, risk tolerance, and market conditions before making a decision.
First, identify which investments in your portfolio have lost value. These investments could include equities, bonds, mutual funds, and other sorts.
Example: You purchased Company A's shares at ₹100 per share, which have since dropped in value to ₹80 per share. You may also have purchased bonds issued by Company B, whose market price has dropped significantly. These assets are considered as your underperforming assets.
When you sell your assets, it should be a loss-making investment. This means you sell them for less than the price you paid for them.
You can use the capital loss you have incurred to reduce or even eliminate the taxes you would have owed if you had sold any item at a higher price. If your capital losses exceed your profits, you can carry them forward for up to eight years.
Example: You sell Company A’s shares, incurring a ₹50,000 capital loss. But, the following year, you sell Company B’s shares, resulting in a ₹30,000 capital gain. Because your losses outweigh your earnings, you will not pay capital gains taxes on the ₹30,000. The remaining ₹20,000 loss can be carried forward for future gains.
The money you save can be reinvested in profitable assets to boost the performance of your portfolio. You can also use them to rebalance your portfolio if your asset allocation has shifted.
These are a few important rules in tax loss harvesting that you should know:
● The capital loss or gain should be reported in the ITR. It should be filed on or before the due date provided by Section 139(1) of the Income Tax Act. Otherwise, it cannot be carried forward.
● There is no set limit for tax loss harvesting in India.
● LTCG can only be set off against LTCG, whereas STCG can be adjusted against STCG and LTCG.
● Losses can be carried forward for eight years from the year incurred.
● In the case of intraday trading, capital gains are treated as speculative business income and taxed at the applicable rates. Losses can be offset against speculative income for a maximum of four years.
Regularly review your portfolio to prioritise which assets can be sold to gain benefits of tax loss harvesting.
Selling loss-making investments for tax loss harvesting allows you to rebalance your portfolio by reinvesting the earnings in other profit-making assets.
Regular portfolio analysis ensures compliance with tax legislation and requirements for tax loss harvesting. This enables you to make more informed decisions regarding the application of tax loss harvesting strategies.
Timing your tax loss harvesting strategy helps you take advantage of the following:
The timing of asset sales influences the amount of capital gains tax owed. Realising losses during high-gain periods helps balance taxable gains, lowering tax liability.
Selling assets when market prices are low allows investors to realise greater losses, which can be used to offset gains in higher-priced markets.
Strategic asset sales timing maximises losses while minimising tax liabilities. Spreading transactions over numerous tax years allows you to optimise the utilisation of carried-forward losses and minimise future tax payments.
Professional counsel on tax loss harvesting can provide useful insights and advice for your financial circumstances. These experts can assist you in understanding complex tax laws, improving your tax strategy, and ensuring regulatory compliance, allowing you to maximise your tax savings.
Tax loss harvesting is a valuable strategy for managing your tax responsibilities while increasing investment returns. You must analyse your portfolio, understand tax rules, and seek professional advice to enhance your financial outcomes and generate wealth over time.
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