Tax Loss Harvesting in India: Save on Capital Gains Tax

Have you ever invested in stocks or mutual funds and ended up with losses? Many investors are unaware that these losses can actually be used to save on taxes. This strategy, known as Tax Loss Harvesting (TLH), allows investors to offset capital gains with capital losses, effectively reducing their tax liability.

This article will explain:

• How tax loss harvesting works
• Relevant sections of the Income Tax Act
• Dos and don’ts for effective tax planning

What is Tax Loss Harvesting?

Tax loss harvesting is the practice of selling investments that have declined in value to realize a capital loss. This loss can then be used to offset capital gains, thereby reducing taxable income.

Here’s how it works:

1. Identify loss-making investments – Review your portfolio for stocks or mutual funds that are currently in the red.
2. Sell to book the loss – Sell these loss-making investments before March 31, the financial year-end.
3. Offset the loss against gains – Use the booked losses to reduce your taxable capital gains.

This strategy is particularly useful for investors who have both profitable and loss-making investments within the same financial year.

How Tax Loss Harvesting Helps Reduce Taxes

Consider an example to illustrate the benefits of TLH:

Without Tax Loss Harvesting

• Short-term capital gains from Stock A: ₹5,00,000
• Tax rate on short-term capital gains (STCG): 15%
• Tax liability: ₹75,000

With Tax Loss Harvesting

• Short-term capital gains from Stock A: ₹5,00,000
• Short-term capital loss from Stock B: ₹2,00,000
• Net taxable capital gain: ₹3,00,000
• Tax liability after TLH: ₹45,000

By implementing tax loss harvesting, the investor saves ₹30,000 in taxes.

Relevant Sections of the Income Tax Act

The Income Tax Act, 1961, provides clear guidelines on how capital losses can be adjusted.

1. Section 70 – Offsetting Capital Losses Within the Same Category

• Short-term capital losses can be adjusted against both short-term and long-term capital gains.
• Long-term capital losses can only be adjusted against long-term capital gains.

2. Section 71 – Adjusting Losses with Other Income

• If capital gains are insufficient to absorb the losses, the remaining losses can be carried forward to future years.
• Capital losses cannot be set off against salary or business income.

3. Section 74 – Carry Forward Rules

• Unadjusted capital losses can be carried forward for up to 8 years.
• These losses can only be set off against capital gains in future years.

Understanding these provisions helps in effective tax planning while remaining compliant with the law.

Dos and Don’ts of Tax Loss Harvesting

Best Practices

• ✔ Book losses before March 31 to ensure they are counted within the financial year.
• ✔ Maintain proper records of transactions for tax filing and potential scrutiny.
• ✔ Reinvest strategically by choosing similar (but not identical) investments to maintain portfolio balance.
• ✔ Use the carry-forward option if capital gains are insufficient to offset losses in the current year.

Mistakes to Avoid

• ❌ Avoid repurchasing the same stock immediately after selling, as it may raise tax avoidance concerns under the General Anti-Avoidance Rule (GAAR).
• ❌ Do not sell investments solely for tax benefits without considering long-term portfolio strategy.
• ❌ Do not assume losses can offset salary or business income—capital losses can only be adjusted against capital gains.

Final Thoughts: Is Tax Loss Harvesting Worth It?

When used correctly, tax loss harvesting can significantly reduce tax liabilities while keeping an investment portfolio optimized. Investors should approach this strategy with a well-thought-out plan and ensure compliance with tax laws.

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