What are tax gain and tax loss harvesting? How can they help you save LTCG tax?

Till January 2018, long-term capital gains on listed equity shares and equity-oriented mutual fund investments were exempted from taxation. In Budget 2018, long-term capital gains (LTCG) tax on equities and equity mutual funds was reintroduced. However, the first Rs 1 lakh LTCG in a financial year has been exempted from taxation. In this article, we will understand how we can use the tax gain harvesting strategy to benefit from this Rs 1 lakh exempt LTCG and save Rs 10,000 net tax every year.

Let us start by understanding what is implied by LTCG tax on equities.

What is LTCG tax?

Section 112A of the Income Tax Act talks about the LTCG tax on equity shares and equity-oriented mutual fund schemes. As per the provisions of this section, the first Rs 1 lakh LTCG in a financial year is exempt from taxation. On the LTCG exceeding Rs 1 lakh, LTCG tax is applicable at 10% without the indexation benefit.

Also Read: How Are Mutual Funds Taxed?

How to save LTCG tax through tax harvesting?

The tax harvesting strategy is the process of booking long-term capital gains of up to Rs 1 lakh every financial year and reinvesting the sale proceeds. It is also known as tax gain harvesting. Long-term capital gains of up to Rs 1 lakh is exempt from taxation. So, it helps investors save Rs 10,000 (10% LTCG tax on Rs 1 lakh LTCG) in net taxes or reduces the tax liability by the same amount.

The investor has to reinvest the sale proceeds immediately as soon as the money reaches their bank account. It helps them continue the wealth creation journey and enjoy the benefits of compounding in the long run. When the sale proceeds are reinvested, the purchase price is reset to the current price and the purchase date is also reset to the current date.

For example, Shweta bought shares worth Rs 5 lakh of ABC company in April 2019. Over the next two years, the company’s financial performance was good, and the value of Shweta’s shares increased to Rs 5.90 lakh by March 2021. Shweta now plans to sell the shares. She will receive Rs 5.90 lakh, out of which her long-term capital gain will be Rs 90,000. Since the LTCG of up to Rs 1 lakh is exempt in a financial year, Shweta will not be required to pay any LTCG tax. In the process, Shweta will be able to save Rs 9,000 net income tax.

As the next step, Shweta has to invest the entire Rs 5.90 lakh again, either in the shares of ABC company or any other company that is appropriate for investment at that time. In the process, Shweta’s purchase date will be reset to March 2021 from the earlier purchase date of April 2019. Her purchase amount will be reset to Rs 5.90 lakh from the earlier purchase amount of Rs 5 lakh. An investor can repeat this process every financial year, book an LTCG of up to Rs 1 lakh, and save net income tax of up to Rs 10,000. 

So, now you know how to save taxes with the tax gain harvesting strategy. But what if an investor is sitting on an LTCG loss instead of LTCG profit? There’s no need to worry. Another investment strategy that can be used is the tax loss harvesting strategy.

Also Read: Looking For Ways To Save Tax On Long-Term Capital Gains? Here Are Some Solutions

What is Tax loss harvesting?

In the tax loss harvesting strategy, an investor can book the long-term capital loss on their equity shares or equity mutual fund units. The booked long-term capital loss can then be used to offset the long-term capital gain made on other equity shares or equity mutual fund units.

For example, Leena made a lump sum investment of Rs 2 lakh in the shares of an IT company in the middle of the COVID-19 pandemic in July 2021. At that time, most IT companies were doing well as the digitalisation theme was in demand. By the second half of 2022, however, shares of most IT companies were not doing well due to US Fed interest rate hikes and fears of a recession in the US. As a result, the value of Leena’s shares went down by 20% to Rs 1.6 lakh.

Following the tax loss harvesting strategy, Leena booked a long-term capital loss of Rs 40,000 in November 2022. She invested the sale proceeds of Rs 1.6 lakh in a Nifty 50 index fund. Leena can use the booked long-term capital loss of Rs 40,000 to offset another long-term capital gain made from either the sale of equity shares or equity mutual fund units.

If Leena doesn’t have any long-term capital gains for the current financial year, she can carry forward the long-term capital loss. She can offset the long-term capital gain in the future years with this long-term capital loss of Rs 40,000. The long-term capital loss booked in a particular year can be carried forward for 8 years. During these 8 years, you can use the carried forward long-term capital loss in any year to offset the long-term capital gain in that particular year.

Let us assume that Leena doesn’t have any long-term capital gain in FY 2022-23. She decides to carry forward the long-term capital loss of Rs 40,000 for 8 years. Let us also assume that Leena makes a long-term capital gain of Rs 30,000 in 2024. She can use the carried forward long-term capital loss of Rs 40,000 to offset the long-term capital gain of Rs 30,000.

As an investor, you can use the tax gain and tax loss harvesting strategy for a lump sum investment as well as a systematic investment plan (SIP) investment.

Also Read: What Is Tax Loss Harvesting?

Use tax harvesting to your advantage and save tax

You can use tax gain harvesting up to an LTCG of Rs 1 lakh in a financial year and save net tax of up to Rs 10,000 every financial year. You can use tax loss harvesting to offset LTCG from another investment in the same financial year. If you don’t have any LTCG in the same year, you can carry forward the long-term capital loss for 8 years. During these 8 years, you can use it at any time to offset LTCG. Thus, as a proactive investor, you can use tax harvesting to your advantage and save tax.

Actionable insights

• During every financial year, review your stocks and equity mutual funds portfolio and evaluate the LTCG.
• Every financial year, you can book LTCG up to Rs 1 lakh and save up to Rs 10,000 in net taxes. But do remember to reinvest the sale proceeds.
• If you have a long-term capital loss, you can offset it against an LTCG in the same financial year.
• If you don’t have any LTCG, you can carry forward the long-term capital loss for 8 years. You can use it during any of these years to offset the LTCG.