Tax loss harvesting is a strategy where you sell investments that are making a loss to reduce your overall tax liability.
The idea is to offset your capital gains with these losses, thereby lowering your taxable income.
How it works:
- If you have sold some investments at a profit (capital gains), you may have to pay tax on those gains.
- To reduce this tax, you can sell other investments that are currently at a loss.
- The losses from these sales can be set off against your gains, reducing your taxable income.
Example:
- You earned a ₹50,000 capital gain from selling some equity mutual fund units.
- You also hold another fund that has a loss of ₹20,000.
- If you sell the fund with the loss, you can reduce your net capital gains to ₹30,000 (₹50,000 – ₹20,000).
- You will pay tax only on ₹30,000.
Key benefits:
- Helps lower your capital gains tax liability.
- Allows you to rebalance your portfolio by exiting underperforming investments.
- Can improve your after-tax returns over time.
Important points to remember:
- Short-term losses from equity funds can be set off only against short-term capital gains, while long-term losses from equity funds can be set off only against long-term gains.
- Any unused losses can be carried forward for up to 8 financial years to offset future gains, provided you file your tax returns on time.
- If you plan to reinvest in the same asset, be aware of rules around avoiding artificial losses (known as “wash sales” in some countries). In India, there is no formal wash sale rule yet, but it’s advisable to maintain a genuine change in your holdings.
Tip:
Consult your tax advisor before using this strategy to ensure it fits your overall investment and tax plan.
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