None of us enjoys paying taxes. Yet we need to pay tax on our income.
What if you could take advantage of a fall in the value of the asset in the portfolio? Are you wondering how it is possible? Try Tax-Loss Harvesting! Tax-Loss Harvesting is an opportunistic way to increase your post-tax returns on investment. Even though an indirect way, tax-loss investing can help you maximize wealth accumulation, especially in the beginning of the life of a portfolio.
What is tax loss harvesting?
Tax-loss harvesting is the practice of selling shares/mutual funds that has experienced a loss. By realizing, or “harvesting” a loss, investors are able to offset taxes on both gains and income. The shares/mutual funds have to move out of the demat account through a delivery sell transaction and can be subsequently purchased the next day.
The sold security is replaced by a similar one, maintaining an optimal asset allocation and expected returns.
How does Tax Loss Harvesting work?
Most of the investors prefer using this strategy at the end of the financial year when they need to file returns. But you can use it throughout the year in a planned manner to keep your capital gains at a relatively lower level. Tax-loss harvesting starts with the sale of the stock or an equity fund which is experiencing a consistent price decline. You feel that the security has lost most of its value and chances of a rebound are bleak. Once the loss is realised, you offset it against capital gains that your portfolio has earned over the period.
Let’s understand this with an example. Assume you have made Rs. 1 Lac in short-term capital gains this year. You will need to pay 15% of this as taxes or Rs. 15000 (STCG). Also, assume that you currently hold stocks that are having an unrealized loss of Rs. 60,000. You can sell these stocks to reduce your net STCG to Rs 40,000. You would hence have to pay 15% of Rs. 40,000 or Rs. 6,000 as taxes – saving you Rs. 9,000 in taxes. This exercise will let you harvest your losses and save on taxes – hence called tax-loss harvesting.