What is Tax Loss Harvesting? An Overview

What is Tax Loss Harvesting?

Tax loss harvesting is a strategy that helps reduce your tax liability by offsetting capital gains with capital losses. By strategically selling underperforming investments, you can lower your overall tax burden and improve your portfolio's long-term performance. It’s a powerful tool that any investor can use with a bit of planning.
 

How Tax Loss Harvesting Works?

Under the Union Budget 2024, gains from the sale of equity instruments are classified into two types of capital gains taxes, with the tax rates remaining unchanged in the Budget 2025:

• Short-term capital gains (STCG): Profits from the sale of assets held for less than 12 months are taxed at 20%.
• Long-term capital gains (LTCG): Profits from assets held for more than 12 months are taxed at 12.5% for gains exceeding ₹1,25,000.

Tax loss harvesting involves strategically selling investments at a loss to offset taxable capital gains. This reduces your overall tax liability and creates an opportunity to rebalance your portfolio.
 

How to Execute Tax Loss Harvesting?

• Identify losing investments – Find stocks or funds in your portfolio that have declined in value and are unlikely to recover soon.
• Sell the underperforming investment – Realize the capital loss by selling the asset.
• Offset gains – Use the realized loss to reduce your taxable capital gains.
• Reinvest strategically – Replace the sold investment with a different one to maintain your portfolio’s balance and growth potential.

How Offsetting Works in Tax Loss Harvesting

Capital losses can be used to offset capital gains, but the offsetting rules differ depending on the type of loss:

• Short-term capital loss (STCL): Can be used to offset both short-term and long-term capital gains. If the total loss exceeds the gains, the remaining loss can be carried forward.
• Long-term capital loss (LTCL): Can only be used to offset long-term capital gains. Any excess loss can be carried forward to future years.
• Carry forward period: Unused capital losses can be carried forward for up to 8 assessment years. However, to carry forward losses, the income tax return (ITR) must be filed within the due date for the year in which the loss occurred.

Tax Loss Harvesting Example

Let’s say you invested in two stocks in May 2024:

Stock A

• Bought in May 2024 and sold in August 2024 for a profit of ₹90,000.
• Since this is a short-term gain, it is taxed at 20%.
• Tax payable = ₹90,000 × 20% = ₹18,000

Stock B

• Bought in May 2024 and sold at a loss of ₹65,000 after six months.
• This is a short-term capital loss, so it can be used to offset the short-term gain from Stock A.

With Tax Loss Harvesting

• ₹65,000 loss from Stock B offsets the ₹90,000 gain from Stock A.
• Net taxable capital gain = ₹90,000 - ₹65,000 = ₹25,000
• New tax payable = ₹25,000 × 20% = ₹5,000

Tax Savings

• Original tax liability: ₹18,000
• After offsetting: ₹5,000
• You saved ₹13,000 using tax loss harvesting
   

Carry Forward Losses

In the example above, the loss was smaller than the gain, but what if the reverse happens—where losses exceed gains?

If your capital loss is larger than your capital gain, the remaining loss can be carried forward for up to 8 assessment years. This allows you to offset future capital gains and reduce your tax liability in subsequent years.

Example Scenario
If you incurred a short-term loss of ₹1,50,000 but had gains of only ₹80,000, you could offset ₹80,000 of the loss this year.
The remaining ₹70,000 can be carried forward to future years and used to offset gains in the next 8 assessment years.
 

Why Use Tax Loss Harvesting?

Tax loss harvesting offers benefits beyond just tax savings:

• Reduce Tax Liability: By offsetting gains with losses, you can lower your tax bill.
• Rebalance Your Portfolio: Selling underperforming assets allows you to reinvest in stronger opportunities.
• Maximize Future Gains: Carrying forward losses ensures that you continue to benefit from tax savings in future years.
• Compound Growth: Tax savings can be reinvested to accelerate your portfolio’s long-term growth.
   

Things to Keep in Mind

Before using tax loss harvesting, consider these important rules:

• Match losses and gains carefully: STCL can offset both STCG and LTCG. LTCL can only offset LTCG.
• Timing matters: Tax loss harvesting is typically done at the end of the financial year to maximize tax benefits.
• Reinvestment strategy: Reinvest the proceeds into a similar but not identical asset to maintain your portfolio’s balance.
   

Is Tax Loss Harvesting Right for You?

Tax loss harvesting can be a valuable strategy if you have investments in a taxable account, have realized significant losses this year, or plan to hold on to your winning investments for the long term. If most of these points apply to you, tax loss harvesting could help you reduce your tax bill and increase your overall returns.

By strategically offsetting capital gains with capital losses, you can lower your tax liability, improve your portfolio’s balance, and maximize long-term wealth. The tax savings can be reinvested, helping your portfolio grow more efficiently over time.

As the year draws to a close, harvest your losses before the year ends and take advantage of this tax-saving strategy.