March is coming. You will start hearing about taxes, deductions and investments from everywhere. And one more thing that can help you save a lot of taxes is Tax Loss Harvesting. Let’s discuss how you can save tax by using tax loss harvesting.
Estimated read time: 2 minutes and 30 seconds
Buckle up, here we go!
What is Tax Loss Harvesting?
Tax-loss harvesting is selling an asset that has experienced a loss in value. By realising a loss, we can reduce or offset taxes on any capital gains income on which a tax is applicable. The sold asset can either be bought back or replaced by a similar one.
Understood anything? No? Let’s understand it in simpler terms.
Whenever you buy an asset like equity, gold, land, etc. You inform the IT department about your purchase. Now, after some time, when you sell the same asset, the IT department asks you to pay a tax on the gains you made from the sale.
They calculated this gain by subtracting the selling price from the buying price. In some cases, like real estate and debt, the IT department allows you to adjust the buying price with inflation (indexation benefit). This way, you pay less tax.
Even after calculating the gain, you need to focus on the holding time period of the asset. If you hold an equity share for more than 12 months, you will pay long-term capital gains tax.
For debt, real estate and gold, they consider it to be long-term when you hold the asset for more than 36 months.
The tax rate is different for short- and long-term capital gains. So, you have to pay capital gains tax based on the holding period. Check the below table for the tax rates.
Holding Period & Capital Gains Tax on Different Capital Assets
But life has its ups and downs, right? You won’t be making a gain always. Sometimes you lose money too.
For that, the government allows us to use capital loss to reduce our taxes. If you make a loss on some investments and make a gain on others, at the end of the financial year, you can set off the capital loss with the capital gain and pay tax only on the net gains.
Also, the government allows carrying forward our capital loss to the next 8 years. This is amazing.
Let’s say you made a capital loss of ₹50 lakhs last year. And this year, you have a capital gain of ₹60 lakhs. You can carry forward last year’s capital loss to this year and set off the losses with the gains. This way you will have to pay tax on the net gains of ₹10 lakhs only.
And as you would have guessed till now. There are some rules.
While setting off losses using tax-loss harvesting, you need to keep the following points in mind:
- Long-term capital losses can be set off against only long-term capital gains. You cannot set off long-term capital losses against short-term capital gains.
- Short-term capital losses can be set off against either short-term capital gains or long-term capital gains.
Also, there is no asset class restriction on the set-off. Hence, losses in equities can be set off against gains in debt, real estate or gold.
As we enter March, you can start planning on how to use tax loss harvesting for your own benefit.
Remember, don’t just look to sell for tax loss harvesting. If you are making a loss on some investment. Re-analyse it and check whether you should hold it or not. Don’t fall for loss aversion.
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