Tax harvesting: Save up to Rs 10,000 income tax on LTCG of Rs 1 lakh through this method
Tax Harvesting: In 2018, the late Finance Minister Arun Jaitley reintroduced long-term capital gains
Tax Harvesting: As the financial year is about to end, the deadline to file taxes is also approaching. And at this eleventh hour, for investors who are still looking for ways to save tax, there's the option of tax harvesting. So, what exactly is tax harvesting? And how does it work?
To understand tax harvesting, it is necessary to know the tax rules for equity. In 2018, the late Finance Minister Arun Jaitley reintroduced long-term capital gains — returns earned by a person from selling equity investments held for more than a year on equities. According to the law, any long-term gain from equity investments that exceeds Rs 1 lakh in a fiscal year is taxable at 10 per cent. For short-term gain, the tax is 15 per cent.
Income Tax: What is Tax Harvesting?
Tax harvesting is a strategy of selling a part of one’s equity units to book long-term capital gains and reinvesting the proceeds in the same stock. With this method, one can save up to Rs 10,000 tax on a long-term gain of Rs 1 lakh.
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To put things into perspective, if an investor has invested Rs 5 lakh in January 2022 and that amount has turned into Rs 5,90,000. Here as per tax harvesting, the investor should redeem the whole amount and no tax will be applied as Rs 5,00,000 as it is the invested amount and the gains of Rs 90,000 does not exceed the Rs 1 lakh limit.
This process can be repeated in the next year. To put things into perspective, if the amount increases to Rs 6,50,000 from Rs 5,90,000, then again investors can redeem the whole amount and the gain of Rs 60,000 (6,50,000 - 5,90,000) will not be taxed.
This process can be done every time the gain is about to exceed Rs 1 lakh. According to Mohit Gang, co-founder and CEO of Moneyfront, it is necessary to note that the amount redeemed should be immediately redeployed in the market.
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Drawbacks of Tax Harvesting
According to Mohit, the following are the drawbacks of Tax Harvesting:
Investors have to take some risk while reinvesting. Reinvestment risk refers to the possibility that an investor will be unable to reinvest cash flows received from an investment. Simply put, If an investor redeems the amount it is possible that while reinvesting, they can incur some loss if the markets are volatile.
Reviewing the portfolio unnecessarily, investors may get into a habit of looking at their portfolio again and again which can create panic if the markets are volatile.
Tax Harvesting: How to set off long-term losses and short-term losses?
According to section 112A of the income tax act:
-Long-term capital losses can be set off against only long-term capital gains.
-Short-term capital losses can be set off against either short-term capital gains or long-term capital gains.
-These losses can also be carry forwarded for 8 years
Mohit explains the set off process with an example. Say, if an investor invests Rs 10 lakhs and the investment has now turned to Rs 9,50,000, then the investor has booked a loss of Rs 50,000. In such a case, the investor should redeem Rs 9,50,000 and immediately redeploy the whole amount. He/she should take the Rs 50,000 loss in his/her books. Now the loss of Rs 50,000 loss can be carried forward and adjusted against any gains in the next 8 years.
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