scorecardresearchHow traders can use tax-loss harvesting to reduce their tax liability

How traders can use tax-loss harvesting to reduce their tax liability

Updated: 17 Mar 2022, 04:29 PM IST

Not all losses are bad. Some can be used to create wealth too. Know how tax-loss harvesting can help.

Paying taxes on capital gains earned

Paying taxes on capital gains earned

With barely 13 days left for taxpayers to announce their income and file their taxes, many are haplessly devising ways to reduce their tax liabilities. This is true for stock market traders and investors too who have been wondering if they can benefit from the losses they suffered from the fall in asset value in their portfolios.

The number of people earning through trading in the stock market has shot up considerably, especially, in the Future & Options (F&O) trading sector. Salaried people are making the most of it as they bet on stocks at lower levels only to sell them when their prices go up a notch higher. Filing taxes on income from trading can be tricky, especially, if you have other sources of income too.

While filing your Income Tax Return (ITR), you must deem any profit or loss made while trading in F&O trades as “Business Income” and include it under “Income from Business or Profession”. While this may seem just an ordinary shift in segregating and collating income under various heads, it can help save on taxes by claiming expenses related to trading.

Claiming expenses on trading

Trading is like any other business, which means that you can also claim the money you spend on your trading setup. So just like other businesses, you can calculate the income from the F&O trades. However, these expenses must be directly related to the income earned from trading. Raj Khosla, founder and managing director, MyMoneyMantra says, “Traders are entitled to claim a slew of deductions while filing their income tax returns since the amount spent to facilitate securities trade can be claimed as an expense subject to certain terms and conditions, and as per predefined limits. Annual membership fees paid to a brokerage firm, stamp duties, exchange transaction fees, securities transaction tax (STT) and Goods & Services Tax (GST) associated with each trade are some of the conventional expenses that can be claimed. The depreciation cost on assets, electricity & rental expenses (if the trader is working from a rented accommodation), expenses related to mobile and internet services, funds spent on maintenance of electronic devices and furniture can also be clubbed under the tax-deductible expenses.”

Also, any expenditure exceeding 10,000 incurred in a day on trading will be considered valid only if not paid in cash.

Why should you file ITR even with no taxable income?

Reporting loss from daily trading

You may think otherwise, but the Income Tax regulations mandate you to report your loss on your ITR though no tax is payable on it. Other than the zero-tax liability on losses incurred during trading, you also get to benefit as losses incurred by trading in F&O can be set off against your business income or any other income barring your salary.

For example, you earn a rental income of 4,80,000 but have suffered losses up to 2,00,00 in F&O trading. While filing your ITR, you can offset your losses against the rental income earned. Then, your taxable income would 2,80,000 which is 4,80,000 minus 2,00,000.

However, if you are not able to fully set off the losses against your current income in a particular year, you can carry forward the same for the next eight years. However, you can carry forward the loss only against your business income in the following years to come, and not any other income.

How does tax-loss harvesting help?

Not many people realize that there are also setbacks in store for them while trading in stocks and equities. The capital gains you have earned from your investments including mutual funds is based on how long you have stayed invested in that fund. To reduce the liability of taxes, some traders resort to tax-loss harvesting just before filing their taxes to lower the tax liability on their investments.

For the unversed, tax-loss harvesting is a ploy that traders and investors deploy by selling their stocks or fund units at a loss to reduce their tax liability on capital gains. The capital gains earned are set off against consciously booked capital losses to pay a lesser tax amount. Of course, they buy the same stocks or fund units in the first week of April to benefit from the upward price movement of the stocks later.

Adhil Shetty, CEO, shared, “Long-term capital gains of more than 1 lakh in a given financial year is taxable at 10% while short-term capital gains (STCG) are taxed at 15%. Any losses you may have made can be offset against your gains while calculating the LTCG and STCG tax. Say you have STCG worth Rs.2L from the sale of equity mutual funds in one year and short-term losses worth Rs.50,000 from the sale of stocks in the same financial year. So, your STCG tax would be calculated on Rs.150,000 (200,000-50,000) instead of Rs.200,000. Note that long-term capital losses can be set off against only LTCG alone, while short-term capital losses can be set off against both LTCG and STCG.”

Many traders and investors are following this trade-loss harvesting practice since 2018 owing to the amendments in the Union Budget 2018 that imposes a tax of 10 per cent on long-term capital gain (LTCG) exceeding 1 lakh. Earlier, the LTCG made on the sale of equity shares and funds was complete tax-free in the hands of the investors.

Harvesting tax losses to earn benefits

Ironically, traders book losses to reduce the tax outflow. Shetty adds, “Tax-loss harvesting is when you set off your capital losses from stocks or equity funds against your short-term and long-term capital gains. This is typically done towards the end of the year when you assess the annual performance of your portfolios and rebalance it to weed out any poor performers but can be undertaken at any point during the year.”

However, tax-loss harvesting also happens when the price of a share is constantly declining. Take, for example, the case of PayTm shares that so many retail investors had bought many shares during its IPO subscription. Some investors also bought shares to benefit from the averaging when the share prices started declining. However, PayTm shares are now down by more than 70 per cent since it got listed forcing many investors to book losses since the chances of the shares rebounding are very much bleak. The investors can offset these losses against the capital gains they had earned from the sales of other shares and funds in their portfolios.

Viewing the PayTm instance as a necessary experience, Shetty added, “Note that tax-loss harvesting must be looked at to reduce losses and not lower taxes. If you invest in poor stocks to save on taxes, you will end up writing off almost all your gains. The aim of making investments is to build up financial security and liquidity and should not be redirected to tax savings.”

Adding to it, Praveen Bhogal, a SEBI-registered investor shares, “Tax-loss harvesting is perhaps the most neglected means to wealth creation in the long run when in fact it allows for long-term capital gain. It is hence profitable for an investor like me, simply because you end up reducing your tax liability.

First Published: 17 Mar 2022, 04:29 PM IST