What is Tax Harvesting? How you can Save Taxes Legally?5 min read

what is tax harvesting

How do you feel as an investor when a major chunk of your gains vanishes due to the tax obligations? 

Of course, the taxation regime serves as discouragement and often keeps prospective investors away from the capital market. 

However, if you are not able to get through with taxation, all you need to know is the technique of tax harvesting. 

Saving taxes over capital gains is just as simple as having a systematic calculative investment plan to balance your portfolio. 

What is Tax Harvesting? 

Tax harvesting is a technique of selling securities at lower profits according to market movements and timing to save on tax and book profits for recreation of the portfolio.

Tax harvesting can be done over equity assets that give you capital gains over time. Equity assets consist of equity shareholdings or equity mutual fund investments. 

Timing is the most essential factor in light of tax harvesting and most investors consider the technique just months before the tax filing process. 

Thee technique will save you from tax obligations from time to time when you plan out how you want to spread your portfolio. 

Tax harvesting simply means investing into equity, selling at declining profit margins and using the whole proceeds to buy another or the same asset. 

The whole procedure accompanies portfolio adjustments and the book adjustments therefore tax obligations are reduced. 

Practical application

Talking in definition terms leads us nowhere, therefore let’s understand the technique in non-specialists’ terms and take up the simplest example. 

Before jumping into the hypothetical situation, knowing the current tax rules is important. 

In India capital gains are taxed according to the timeline, the timeline is holding investment above 12 months period is considered as long term gain investment and redeeming before that period brackets to short term gain investment.

Taxation on Long term capital gain is 10% and short term capital gain is 15% if the capital gain is above the limit of ₹ 1,00,000.

Let us consider you as an investor who prefers equity funds. Your initial investment money is ₹ 2,00,000 and you want to invest it for 3 years in an equity fund.

Case 1 – non-tax harvesting investment 

Suppose you invested the sum of ₹ 1,00,000 on 1st April 2020, and you plan to redeem it on 7th April 2023. The investment value has jumped to ₹ 2,00,000 by that time. 

Now as the investment is long term and the capital gain is ₹ 1,00,000 the tax obligation would be 10% x ₹ 1,00,000 = ₹ 10,000. 

The total gain in your hand would be ₹ 90,000 and an initial amount of ₹ 1,00,000.

Case 2- tax harvesting investment 

Suppose you invest the same ₹ 1,00,000 on 1st April 2020 and you plan to redeem on 2nd April 2021 with the total valuation at that time being ₹ 1,40,000. In this case, your investment is long term but as the capital gain is less than ₹ 1,00,000 no tax obligation is imposed. 

Now that you have ₹ 1,40,000 in hand, you re-invest this amount in the same equity fund and redeem it again on 5th April 2022, lets’s say now the investment is valued at ₹ 1,60,000. Again, your investment is long-term, but capital gain is ₹ 20,000; therefore, no tax is imposed. 

By this time your cash is ₹ 1,60,000 and you wish to repeat the process of re-investing the entire amount. The redemption value is at ₹ 2,00,000 as of 7th April 2023. Since long term investment but capital gain is ₹ 40,000 which is less than ₹ 1,00,000, no tax payment is required. 

In this case, your initial investment was ₹ 1,00,000 and your final money in hand was ₹ 2,00,000 with a capital gain of ₹ 1,00,000 over three years. 

Whereas when no tax harvesting was used, the final gain in hand was ₹ 90,000 over 3 years. 

Clearly, the simplest example explains how a huge sum of gains can be saved from taxation losses by planning redemption systematically on your equity holdings. 

Benefits of Tax Harvesting

In basic terms, tax-loss harvesting primarily cuts down your tax cost on gains and therefore increases your consumable gains.

Another advantage can be that frequent redemption with tax balancing will help you diversify your portfolio from time to time and look for asset classes in the bucket list with increased initial amounts.

For example, if your portfolio has an investment at a loss of ₹ 50,000 and another at a profit of ₹ 70,000. You may sell the loss-making investment and the amount of loss of ₹ 50,000 will be deducted from the profit-making investment for the calculation of actual taxable profit. That is ₹ 20,000 would be the taxable amount but since it is less than ₹ 1,00,000 the portfolio remains exempted from tax.

Risk and returns as a whole remain aligned and balanced due to portfolio adjustments and therefore planned objectives are likely to be achieved.  

Limitations of Tax Harvesting 

There can be some cases when the tax is not completely saved but is postponed with the help of tax harvesting. 

This can be a limitation of tax harvesting as equity markets are robust in nature and you never know what uncertainty can rule out your investment plan. 

Long term losses can only be set off against long term gains in portfolio adjustment whereas short term losses can be set off against long term gains or short terms gains. 

This can be a question of choice and market analysis over what type of reinvestment you plan with the redemption amount.

Bottom line 

To save your tax obligations, you need to focus on planned investing with synced profit margins and a safety net against taxation.

Limiting your profits and booking less of them can sometimes help you save the taxation and hence computing high consumable capital gains.

Being precocious with a volatile market and timing the bulls and bears is everything that investors need to be good at.

Knowing the spots to enter and exit will add up value to your tax harvesting technique further accumulating more profits.

Lastly, tax harvesting will generate the highest benefits when done recurring and planned just according to your goals of investment.



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