Home/Blogs/Tax Harvesting 101 : Explore the Smart Strategy for Investors

Tax Harvesting 101 : Explore the Smart Strategy for Investors

stock market
30 Sep 20246 mins readBy MOFSL

Introduction

Paying taxes is the last thing on your mind when you invest, but it is a significant aspect that influences your investment returns. If you want to save on taxes, you can try tax harvesting. Also known as tax-loss harvesting, this strategy involves selling assets that have declined in value to offset the capital gains from other profitable investments. It is a widely used method to reduce tax liability and boost net returns from investments. Read along to learn if tax harvesting is a good strategy to adopt as an investor in stock and mutual funds.

How tax harvesting works

Tax harvesting is applied to mutual funds and other eligible investments in the following ways:

·   Offsetting capital gains

If you have invested in mutual funds and stocks, you are liable to pay a long-term capital gains tax of 12.5% on gains exceeding ₹1.25 lakh in a year. If your gains qualify as short-term capital gains, you incur a tax of 20%. However, STCG is added to your overall income and taxed as per your tax slab in case of debt funds.

​​​​​​​Open Demat Account and Start Trading!

Considering this taxation method, offsetting capital gains refers to balancing your losses against gains to reduce tax liability. For example, when you realise capital gains on the sale of a stock, you can sell another investment at a loss. This offsets your gains and reduces tax liability on them.

·   Reducing taxable gain

Since LTCG applies to capital gains above ₹1.25 lakhs, you can save on the tax by reducing the gains. You can keep an eye on your gains and sell the investment before the gains exceed ₹1.25 lakhs. It is one of the ways to reduce your taxable income. But you still have to hold the gains for more than 12 months for this strategy to work against the LTCG tax. Otherwise, the gains will fall under the STCG category. Also, you would have to alert and track your fund's or security's performance.

Benefits of tax harvesting

Implementing the tax loss harvesting strategy involves the following benefits:

·   Minimise tax liability

The main benefit of tax harvesting is reduced tax liability, especially if you have a large portfolio. Instead of paying taxes on profits, you can neutralise those gains with losses from other investments.

·   Optimise portfolio performance

With tax harvesting, you can rebalance your portfolio. You can sell underperforming assets and reinvest the capital into better-performing investments. This helps with proper asset allocation.

·   Increase long-term gains

By regularly implementing tax harvesting, you can protect a larger portion of your portfolio from taxation. As a result, you allow more returns to compound over time and increase long-term gains.

·   Carry forward losses

The excess losses that you cannot use in the current financial year can be carried forward. This allows you to offset future gains with past losses for up to 8 years, providing long-term tax efficiency.

·   Offset different kinds of gains.

You can apply tax harvesting to both short-term and long-term capital gains, making it flexible. It also works across different types of investments, including stocks, bonds, and mutual funds.

Is tax harvesting always a good strategy: Important considerations

All in all, tax loss harvesting is a good strategy but, its application and effectiveness depend on these considerations:

·   Timing risk

Selling investments prematurely to harvest a loss can result in missed opportunities. For example, it can recover soon and may lose out on future gains. Hence, you should consider the timing and make the move consciously.

·   Wash-sale rules

The wash-sale rules prevent you from repurchasing the same or similar assets within a specified period (typically 30 days) after selling them for a loss. Check such rules before tax harvesting.

·   Transaction costs

Frequent buying or selling of investments for tax harvesting may lead to higher transaction costs. This can counter-serve your tax savings. You should consider the exit loads and penalties to stay prepared.

·   Opportunity cost

Tax harvesting can potentially hinder your long-term growth strategies. Selling an asset purely to offset gains can lead to exiting from promising stocks. It is better to take this into account.

·   Management complexity

When you implement a tax harvesting strategy on a portfolio of a diverse set of assets, management can get tricky. You want to have it streamlined and do a cost-benefit analysis with your financial advisor.

Conclusion

Tax harvesting is a valuable tool to optimise your investment returns by lowering your liability on capital gains tax. However, the decision to use this strategy should be well-thought-out. Consider your overall financial strategy, market conditions, and long-term goals. If you are a high-net-worth individual, tax harvesting can especially benefit you with high-tax savings. As a smaller investor, you can manage tax on your diversified portfolios with this tax-saving method. Make sure to weigh the risks and associated costs to make the most of it.

 

Financial Calculators: SIP Calculator | SWP Calculator | Compound Interest Calculator | EMI Calculator | FD Calculator | Retirement Calculator | Option Value Calculator | Inflation Calculator | Lumpsum Calculator

 

Popular Stocks: ICICI Bank Share Price | HDFC Bank Share Price | CDSL Share Price | UPL Share Price | TCS Share Price | BHEL Share Price | Trident Share Price | IRFC Share Price | Adani Power Share Price

 

Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
Open Demat Account
I wish to talk in South Indian language
By proceeding you’re agree to our T&C
Click here to see your activities