Tax Loss Harvesting in India: A Smart Strategy to Save Taxes

Tax season is here, and every investor looks for ways to reduce tax liabilities. One lesser-known but highly effective strategy is Tax Loss Harvesting (TLH). This strategy allows investors to offset capital gains by selling loss-making investments. If you're wondering how this works and whether it's legal in India, this article will simplify the concept for you.

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What is Tax Loss Harvesting?

Tax Loss Harvesting is a strategic investment practice where investors sell underperforming assets at a loss to offset taxable capital gains. This approach helps reduce overall tax liability by balancing gains with losses, ultimately lowering the investor's tax burden.

For example, if an investor makes a profit on one stock but incurs a loss on another, they can use the loss to reduce the taxable gain. If losses exceed gains, the excess can be carried forward to offset future gains, as per tax regulations.

How Does Tax Loss Harvesting Work?

Tax Loss Harvesting follows a simple 4-step process:

• Identifying Loss-Making Assets – Reviewing the portfolio and selecting assets that have significantly declined in value and are unlikely to recover.
• Selling & Booking Losses – Selling these assets to realise a capital loss.
• Offsetting Gains – Applying these losses to reduce taxable capital gains:
• Short-term capital losses (STCL) can be used to offset both short-term (STCG) and long-term capital gains (LTCG).
• Long-term capital losses (LTCL) can only be used to offset LTCG.
• Carrying Forward Excess Losses – If total losses exceed gains in a financial year, the remaining loss can be carried forward for up to 8 assessment years, provided it is declared in the Income Tax Return (ITR).

By following this method, investors can effectively lower their tax burden while keeping their investment portfolio optimised. 

Rules for Setting Off Capital Losses in Tax-Loss Harvesting

When setting off capital losses through Tax Loss Harvesting, it is essential to follow these rules:

Short-Term Capital Gains (STCG) Offset Rules

(STCL Can be adjusted against both Short-Term (STCG) and Long-Term Capital Gains (LTCG):

• Applies to: Equity shares and equity-oriented mutual funds held for 12 months or less.
• Tax Rate: 15% under Section 111A of the Income Tax Act.
• Offset Rules: STCL can be adjusted against both STCG and LTCG.
• Important Update: For securities sold before July 23, 2024, STCG will still be taxed at 15%.

Long-Term Capital Gains (LTCG) Offset Rules

LTCL Can only be adjusted against Long-Term Capital Gains (LTCG). LTCL cannot be offset against Short-Term Capital Gains (STCG).

• Applies to: Listed equity shares and equity-oriented mutual funds held for more than 12 months.
• Tax Rate: Gains exceeding ₹1.25 lakh are taxed at 12.5% under Section 112A, without indexation benefits.
• Offset Rules: LTCL can only be adjusted against LTCG.
• Exemption: LTCG up to ₹1.25 lakh per financial year is tax-free.
• Important Update: For securities sold before July 23, 2024, LTCG exceeding ₹1 lakh was taxed at 10%.

Carry Forward Rule

If your capital losses exceed your gains in a financial year, you can still make use of them through the Carrying Forward Losses provision. This allows you to optimise your tax efficiency over time.

• Unused capital losses can be carried forward for up to 8 assessment years.
• To claim this benefit, you must report the losses in your Income Tax Return (ITR) before the due date.
• These carried-forward losses can be set off against eligible capital gains in future years, helping reduce tax liability over time.

For a clearer understanding, refer to the table below outlining the rules for setting off capital losses in Tax Loss Harvesting.

Tax Loss Harvesting Example 

Arjun had gains from stocks and mutual funds but also held some loss-making investments. By using Tax Loss Harvesting (TLH), he reduced his overall tax burden.

Before Tax Loss Harvesting

After-Tax Loss Harvesting

Arjun sold an underperforming stock and realised a ₹1,00,000 short-term capital loss (STCL). This loss was offset against his short-term capital gains (STCG), reducing his taxable income.

Tax Savings from Tax Loss Harvesting

By using Tax Loss Harvesting, Arjun successfully saved ₹20,000 in taxes while keeping his portfolio optimized.

Who Should Consider Tax Loss Harvesting?

The following individuals and groups can benefit from implementing TLH:

High Net-Worth Individuals (HNIs)

• Investors with significant capital gains from stocks, mutual funds, or other assets.
• TLH helps them reduce taxable income and lower their overall tax liability.

Frequent Traders & Active Investors

• Individuals who actively trade in equities and mutual funds generate both profits and losses.
• TLH helps them balance short-term gains (which are taxed at a higher rate) with realised losses.

Long-Term Investors & Portfolio Managers

• Investors hold a diversified portfolio that includes both profitable and underperforming assets.
• TLH allows them to sell loss-making investments strategically, reducing taxable capital gains.

Taxpayers with Carry-Forward Losses

• Those who have accumulated capital losses from previous financial years.
• These losses can be set off against future capital gains for up to 8 assessment years, optimising tax efficiency.

Mutual Fund Investors

• Individuals with capital gains from equity-oriented mutual funds.
• By harvesting losses from underperforming funds, they can reduce taxable gains.

Investors Facing Short-Term Capital Gains (STCG) Taxes

• STCG is taxed at 15% in India, making it more expensive than long-term gains.
• TLH helps investors offset short-term gains by selling loss-making assets, reducing their tax liability.

Those Rebalancing Their Portfolio

• Investors looking to exit underperforming stocks or funds while maintaining their asset allocation.
• TLH ensures tax-efficient restructuring of the portfolio.

Investors in a Falling Market

• If the market is experiencing a downturn and certain investments are losing value, selling them strategically can cut tax bills.

When to Use the Tax-Loss Harvesting Strategy?

Tax-loss harvesting is a powerful strategy, but knowing when to use it can help maximise your tax savings. Here are the best times to implement it:

• When You Have Capital Gains to Offset: If you’ve made profits from selling stocks, mutual funds, or other assets, you can use tax-loss harvesting to reduce your taxable gains.
• In a Falling Market: If the stock market is declining and some of your investments are in the red, selling them strategically can help cut your tax bill.
• Before the Financial Year-End: Investors should execute tax-loss harvesting before the fiscal year's last trading day. For FY 2024-25, this means completing transactions by March 28, 2025, as markets will be closed on March 29, 30, and 31.
• When You Have Short-Term Gains: Since short-term capital gains (STCG) are taxed at a higher rate, offsetting them with short-term capital losses (STCL) can lead to significant tax savings.
• To Carry Forward Losses for Future Gains: If your losses exceed your gains, you can carry them forward for up to 8 years to offset future capital gains, ensuring long-term tax efficiency.

Key Benefits of Tax Loss Harvesting

Beyond tax savings, tax loss harvesting provides multiple advantages for investors. Here’s how it can help you:

Pay Less Tax By offsetting capital losses against capital gains, tax loss harvesting helps reduce your taxable income, ultimately lowering your tax liability.

Carry Forward Losses

If you can’t offset all your losses in the current financial year, you can carry forward both Short-Term Capital Losses (STCL) and Long-Term Capital Losses (LTCL) for up to 8 assessment years and adjust them against future capital gains.

Offsets Both Short-Term & Long-Term Gains

• STCL can be offset against both STCG & LTCG, offering greater flexibility.
• LTCL can only be offset against LTCG, ensuring tax efficiency for long-term investments.

Rebalance Your Portfolio

Selling underperforming assets through tax loss harvesting not only helps reduce taxes but also enables you to reinvest in better-performing stocks or funds, improving overall portfolio performance.

Key Considerations for Tax Loss Harvesting

• Timing plays a crucial role in tax loss harvesting. Selling underperforming assets at the wrong time can reduce potential tax benefits or even result in avoidable losses.
• Since tax loss harvesting can be complex, it’s advisable to consult tax experts to ensure compliance with tax regulations and maximise savings.
• Additionally, understanding whether an asset falls under short-term or long-term classification based on its holding period is essential. This classification determines the type of capital gain or loss it generates and how it can be offset effectively.

Maximise Your Tax Savings with Expert Guidance!

Need help implementing tax loss harvesting strategies effectively? Our CAs are here to guide you in optimising your tax savings. Don't wait until the last date to file your ITR—take action today!

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