What if you could profit from a decline in the portfolio asset's value? Would that be even possible? Of course, it is, through Tax Loss Harvesting! You can make the most of your money, by taking advantage of this tax hack.
Profits or Capital Gains are an obvious (and desired) byproduct of investing in the markets. Depending on the length of time you held onto the stocks or fund, you may be subject to taxes on the capital gains you've accrued.
However, by selling some of your loss-making investments, you can reduce your total profits, and thereby reduce the amount of tax you pay.
How Do You Do It?
In order to lower investment taxes, all you need to do is minimise gains. Say you have two stocks:
Stock A - which currently has a gain of Rs. 5 lakh
Stock B - which currently has a loss of Rs. 2 lakh
If you sell Stock A, you will make a gain of Rs. 5 lakh, and at a 15% tax rate, you will end up paying a capital gains tax of Rs. 75,000.
However, if you even sell Stocks A and B, the total profit will come down to Rs. 3 lakh, and at a 15% tax rate, you will end up paying a capital gains tax of Rs. 45,000.
What Next?
Ideally, you need to deploy the above strategy before March 31, so that you end up with a lower amount of gain for the financial year. However, there are two things to keep in mind - primarily surrounding your view on the loss-making investment.
An investment that is currently making losses, may or may not be a good investment
If you believe in the long-term prospects of the stock, and believe it will bounce-back, and even gain significantly after, you can just buy the stock back on or after April 1. Essentially, you are just showing a loss and then making the same investment again. Nothing changes other than a lower tax bill for you!
However, if you don’t believe in the long-term prospects of the stock, this is a good opportunity to get rid of the stock and refine your portfolio. The strategy can just make you rethink your decisions, and even improve the health of the portfolio. After all, it is better to get rid of a wrong decision and deploy the money at a better place, than hopelessly wait for it to come to cost or profit.
Keep in Mind
Tax loss harvesting doesn't make up for the losses, but it can help ease your pain by saving you money on taxes.
Keep in mind two things while you deploy this method:
Only long-term capital gains and losses can be offset against each other. Your long-term losses cannot be used to offset your short-term gains.
Gains on investments held for longer than a year can be offset by losses on those held for a shorter time period.
A great tool if used well, Tax Loss Harvesting is a neat trick to set off your taxation liabilities in a fairly simple manner, and isn't illegal either!