Q. I am Ranjan. I want to harvest tax loss for my investments. How does tax-loss harvesting work? How can it help minimise my tax outgo? What are the risks?
Tax-loss harvesting is a strategy used to minimise tax liability by selling investments that have declined or are declining in value. When an investment is sold at a loss, the investor can use that loss to offset capital gains realised from other investments. The idea is to use the capital losses from underperforming investments to balance the capital gains generated from profitable ones, thereby reducing the overall tax burden.
Also Read: How to reduce income tax by loss harvesting in weak stock market — explained
Tax-loss harvesting allows you to maintain the desired asset allocation while still taking advantage of tax benefits. It provides a two-fold benefit:
- Helps investors minimise their tax liability while allowing them to rebalance their portfolios.
- Proceeds from the sale of the underperforming assets can be reinvested in more promising opportunities while maintaining a diversified portfolio.
What you can do
You may set off short-term capital losses against short-term capital gains or long-term capital gains. However, you can set off long-term capital losses only against long-term capital gains.
Short-term capital losses can be offset against short-term capital gains
For example, if you have a ₹1,000 short-term capital loss and a ₹1,500 short-term capital gain, you can offset the losses against the gains and only pay taxes on the net gain of ₹500.
Also Read: How to set off capital losses in stock market to reduce your income tax liability?
Long-term capital losses can be used to offset long-term capital gains
For instance, if you incur a ₹2,000 long-term capital loss and have a ₹3,000 long-term capital gain, you can offset the gains by the losses, resulting in a net taxable gain of ₹1,000.
If you have both short-term and long-term capital losses and gains, you can offset short-term losses against short-term gains and long-term losses against long-term gains.
If there’s still a net loss or gain after offsetting within the same category, you can then offset any remaining net short-term loss against any remaining net long-term gain, or vice versa.
Usually, tax loss harvesting is done towards the end of the tax year to review investment positions and strategically sell assets to optimise the tax situation before year-end. During years when your income is higher than usual, tax loss harvesting can be used to offset capital gains and potentially reduce your taxable income.
If you have unused capital losses from previous years, tax loss harvesting can be employed to offset gains and fully utilise any carried-forward losses.
When overall market conditions are negative, many investments may experience losses. Tax loss harvesting during a market downturn allows you to capture losses for tax purposes.
International Money Matters Pvt Ltd (IMMPL) is a SEBI-registered investment advisory firm, established 22 years ago. If you have any personal finance query, click here to book a free call with our advisor.
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Published: 09 Mar 2024, 11:14 AM IST