It is a well-known fact that every investor has to pay taxes on the capital gains earned on an investment in stocks and mutual funds, but none of us want to pay high taxes and demand the maximum possible post-tax returns. Will you amaze hearing that some opportunities are available in the stock market to reduce your net tax payable liabilities? Have you ever heard about tax-loss harvesting? If not, the article is for you that presents an in-depth review of tax-loss harvesting, how to optimize the benefits of tax loss harvesting to minimize your short-term and long-term tax payment outgo, and the process to get a tax-loss harvesting report in Zerodha.
What is Tax Loss Harvesting?
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In simple terms, Tax loss harvesting is the practice of selling your investment in shares/securities or mutual funds at a loss. In other words, the process of booking unrealized losses on your portfolio with the aim to minimize capital gain tax is called harvesting.
Now, the amount of capital losses that an investor has booked by offloading his investment can be offset against the capital gains earned on an investment in other securities and mutual funds. In this way, you can reduce your net capital gains for the given financial year, on which the capital gain tax is levied, thereby reducing your tax liabilities or tax burden.
Thus, the process of offsetting capital losses against gains to save net tax obligations is called tax-loss harvesting. Investment sold at loss can be purchased back or replaced with a similar investment. India’s top discount broker, Zerodha provides the opportunity of tax-loss harvesting to its clients.
Types of Capital Gain Taxation
Investment in the share market is subject to two types of capital gain taxation obligations; short-term capital gain and long-term capital gain (LTCG). Let’s understand both the capital gain tax implications on traders and investors;
- Short-Term Capital Gain (STCG): Profits made by selling stocks or equity mutual fund units held for less than 1 year are called STCG. As per the taxation rules, STCG attracts 15% of the tax rate.
- Long-Term Capital Gain (LTCG): Profits earned by offloading stocks or equity mutual fund units that an investor keeps in his portfolio for more than a year are called LTCG. Currently, the rate of tax applicable on LTCG is 10% but LTCG upto Rs. 100,000 are tax-exempted means no tax is charged on capital gains worth Rs. 100,000, and gains above the exemption limit are charged at a 10% tax rate.
How Does Tax Loss Harvesting Work?
Let’s understand tax loss harvesting further with an example to have a clear idea of how it helps to reduce taxes. Two scenarios have been considered; one without harvesting and one with the use of tax-loss harvesting to know the net difference between the amount of tax payable.
Example 1: Tax-Loss Harvesting on Short-term capital gains
Suppose, you have made a short-term capital gain of Rs. 1,50,000 in a financial year, then without harvesting, your tax liability will be as follows;
Short-term capital Gain Tax [without harvesting] = Short-term capital gain * Short-term capital gain tax rate
= Rs. 1,50,000*15%
= Rs. 22,500
Now, assume that in the same scenario, the investor is also holding an investment in other shares that are currently running at an unrealized (un-booked) loss of Rs. 60,000. If he wants to get the benefit of tax-loss harvesting he must have to sell or dispose-off such investment at losses. Now, the tax will be as follows;
Net Short-term capital gain [With Harvesting] = Short-Term Capital Gain – Short-Term Capital Loss
= Rs. 1,50,000 – Rs. 60,000
= Rs. 1,10,000
Investor’s net capital gain has been reduced by 60,000 and reported at Rs. 1,10,000, on which 15% tax is applicable such as follows;
Short-term capital Gain Tax [With Tax-loss harvesting]
= Rs. 1,10,000*15%
= Rs. 16,500
Net STCG tax difference = Capital Gain Tax (Without Harvesting) - Capital Gain Tax (With Harvesting)
= Rs. 22,500 - Rs. 16,500
= Rs. 6,000
So, the net difference between tax payable without and with harvesting is Rs. 6,000 which means that tax-loss harvesting helps to reduce capital gain tax outgo by Rs. 6,000.
Example 2: Tax-Loss Harvesting on Long-term capital gains
Suppose an investor has earned LTCG of Rs. 4,00,000, so without taking harvesting advantage, the calculation of tax payable will be as follows;
Net LTCG = Total LTCG – Tax-Free/Exemption limit
= Rs. 4,00,000 – Rs. 100,000
= Rs. 3,00,000
LTCG Tax (Without Harvesting) = LTCG *10%
= Rs. 3,00,000*10%
= Rs. 30,000
In the second scenario, assuming that the investor also has some stocks in his portfolio for more than a year and currently, he is having a portfolio loss of Rs. 120,000. To take the tax-loss harvesting benefits, the investor sells his entire portfolio at the given losses, now, the LTCG tax will be as follows;
Net LTCG (with harvesting) = LTCG – Tax-free/Exemption limit – Long-term capital loss
= Rs. 400,000 – Rs. 100,000 – Rs. 1,20,000
= Rs. 1,80,000
LTCG tax (with harvesting)
= Rs. 180,000*10%
= Rs. 18,000
Net LTCG tax difference = LTCG tax without harvesting – LTCG tax with harvesting
= Rs. 30,000 – Rs. 18,000
= Rs. 12,000
Thus, in that case, tax-loss harvesting has reduced the net LTCG tax payable liability by Rs. 12,000
Tax-Loss Harvesting Rules or principles
- STCG: Short-term capital losses on your portfolio in a financial period can be set off or compensated against the short-term capital gains as well as long-term capital gains.
- LTCG: Long-term capital losses can be set off against long-term capital gains (LTCG) only. It means you cannot be subtracting it from the short-term capital gains.
Important Note: If you only have capital losses both in the short-run and long-run, means you won’t be able to take the advantage of tax-loss harvesting opportunity. Similarly, LTCG upto the exemption limit of Rs. 100,000 does not provide any harvesting benefits.
Tax Loss harvesting report in Zerodha Kite
Zerodha provides a tax-loss harvesting report to customers on the integrated console back office portal. It provides complete details about realized and unrealized short-term and long-term capital gains as well as losses. Thus, the harvesting report helps you know the exact amount of harvesting opportunities available in the given financial year.
Steps to download the tax-loss harvesting in Zerodha Kite via Console
- Log in to the Kite platform.
- Go to the Console reporting dashboard.
- On the top menu bar, click on the “Reports” option.
- Now, tap on the “Tax-loss harvesting” field.
- The details about the short-term and long-term tax-harvesting opportunities will be available to you.
Tax-Loss Harvesting: Final Verdict
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Hopefully, everything about tax-loss harvesting is crystal clear to you. Now, it is clear that harvesting is simply the way to minimize your net capital gains on which tax rate is applicable by booking unrealized losses. The harvesting opportunity is available on short-term and long-term capital gain and helps an investor to reduce the amount of capital gain tax outgo and thereby get maximum post-tax returns.
