Explained: Tax Harvesting And How It Maximises Your Returns
Tax harvesting is a smart strategy to reduce your tax bill by strategically selling and reinvesting investments to maximise exemptions and retain more of your returns.
Paying taxes is an unavoidable part of financial life. Be it income tax, GST or capital gains tax, they all eat into your earnings. But when it comes to long-term capital gains (LTCG) from mutual funds, a strategy known as tax harvesting can help reduce income tax burden. Before 2018, LTCG from equity investments were tax-free. However, things changed when former Finance Minister Arun Jaitley introduced a 10% tax on gains exceeding Rs 1 lakh in a financial year. LTCG is the profit earned from selling equity investments held for over 12 months. While the exemption of Rs 1 lakh provides relief to some, many investors fail to use it because their gains remain unrealised.
What Is Tax Harvesting?
Tax harvesting is a process where investors reduce their tax liabilities by selling underperforming investments at a loss. These losses can be used to offset capital gains from profitable investments, thereby lowering the overall tax burden.
If the losses exceed the gains, they can even be carried forward to future tax years, further optimising after-tax returns on an investment portfolio.
How Does Tax Harvesting Work?
Tax harvesting is a simple two-step process:
Selling investments at a loss: When certain investments in your portfolio lose value and fall below their buying price, they are considered to be in a loss position. Tax loss harvesting involves selling these underperforming investments while they are at a loss. This allows investors to realise these losses for tax purposes.
Offsetting capital gains taxes: Capital gains taxes apply when you sell investments at a profit. But by strategically selling investments at a loss, you can offset the capital gains tax liability. The losses harvested from poor-performing investments are used to reduce the taxable gains from the sale of other investments. This process ultimately lowers the investor’s overall tax liability.
What Is The Strategy Behind Tax Harvesting?
Tax-loss harvesting is a smart investment strategy to reduce tax liabilities. Investors usually use this approach towards the end of the financial year while reviewing their portfolios. The process involves selling investments that have declined in value to offset capital gains from profitable assets.
By strategically implementing tax-loss harvesting, investors can lower their overall tax burden. For example, losses from one security can be used to offset gains from another, effectively reducing or even eliminating the capital gains tax. This approach not only helps in tax savings, but also improves after-tax returns, making it a valuable tool for long-term wealth management.
