The financial year 2022-23 (FY23) turned out to be a tough one to make money from the stock market compared to previous financial years. People who did make some and booked profits may not want to lose a penny on taxes. While taxes are unavoidable, there are ways to reduce tax liability on your capital gains. One such is tax loss harvesting. One can do it at any time of the year but is often executed in March before the ongoing financial year ends.
Tax loss harvesting
This is about adjusting your booked profits against the losses. “Tax-loss harvesting is a practice of selling an investment instrument (like stocks) that has incurred a loss to help the investor offset and therefore reduce taxes on any capital gains earned (income) which is subject to taxation,” explains Santosh Joseph, CEO and Founder, Germinate and Refolio Investments.
“The sold security can be bought back or replaced by a similar one,” he adds.
For example, assume you have booked ₹1 lakh short-term capital gains (STCG). You need to pay STCG tax at 15 per cent, that is, ₹15,000. If you have incurred losses on your other investments, you may book losses to offset those against capital gains. Suppose you book a loss of ₹70,000. Now your net capital gains would come in at ₹30,000. Its 15 per cent, ₹4500, would be your tax liability on capital gains.
What about long-term capital gains?
LTCG up to ₹1 lakh in a year is tax free. If it crosses beyond ₹1 lakh, you may offset it with long-term capital losses. You cannot do it against short-term capital losses. Remember short-term capital loss can be set off against short-term capital gains as well as long-term capital gains. However, long-term capital gains can only be set off against long-term capital loss. Interestingly, both short term and long-term loss can be carried forward for 8 assessment years immediately following the assessment year in which the loss was first computed.
There is another important hack in the case of LTCG. Since ₹1 lakh LTCG is tax free each year, you may take advantage of it by revising the buying price upwards. For example, you may sell a stock to book profits and buy it again soon after. “This will help you increase your average cost of the share,” says Joseph. It is called tax harvesting which helps you save ₹10,000 in capital gains each year.
Risks in tax loss harvesting
While the concept of tax loss harvesting appears simple, it is not as simple in practice. You need to buy back the stock right after selling it to neutralise its impact on your portfolio. Settlements take time. Doing that in a gap of 2-3 days may affect your portfolio in case a sudden news hits the market on an upside or a downside. The situation is trickier in case of mutual funds where redemptions take a lot of time. One needs to also take into account exit loads and lock-ins.
“Booking profits and losses to offset capital gains and reduce tax liability could backfire if the sold stocks move up significantly and you are not able to buy the stock back to maintain your portfolio’s requirements,” cautions Joseph.
Tax loss harvesting is useful but is a professional’s job. You need to approach your tax advisor to take a call on the same. Don’t sell stocks just to save taxes. Keep other aspects in mind. A professional can help you with it. Alternatively, there are platforms such as Kuvera and Zerodha which suggest you personalised tax loss harvesting actions at the portfolio level.