Tax Harvesting: What is it and how can it optimise your tax liabilities?

Tax harvesting involves strategically selling investments at a loss to offset capital gains and reduce tax liability. By realising losses, investors can decrease their taxable income, potentially saving money on taxes. This technique is commonly used to optimise investment portfolios.

Tax harvesting is a strategy used by investors to maximise tax benefits, particularly concerning long-term capital gains (LTCG). Before 2018, there was no tax imposed on LTCG. However, when the government introduced this tax, they provided a small benefit: capital gains up to ₹1 lakh are tax-free in case of equities.

However, many investors find it challenging to fully utilise this ₹1 lakh exemption. In India, taxes are levied on realised profits, meaning the gains must be actualized through the sale of assets. This poses a dilemma for investors whose portfolios have accrued significant profits but haven't yet sold their assets to realise these gains.

Also Read: How to harvest tax-free capital gains from stocks and equity oriented mutual funds?

Here's where tax harvesting comes into play: 

Let's consider an example: Shubham has been holding onto his stocks for three years, and his long-term capital gain amounts to ₹3 lakhs. Deducting the ₹1 lakh exemption, he is left with ₹2 lakhs, on which he would have to pay a 10% tax, amounting to ₹20,000. 

On the other hand, suppose another investor, let's call him Varun, adopts the tax harvesting strategy. Varun sells a portion of his profit-making shares every year, realising his LTCG annually. By doing so, Varun effectively resets the cost basis of his investments each year, ensuring that his gains remain within the ₹1 lakh exemption limit. Therefore, even after three years, when Varun’s total LTCG amounts to ₹3 lakhs, he owes no tax because he has systematically realised and reinvested his gains each year.

In essence, tax harvesting involves periodically selling profitable investments to lock in gains and then immediately repurchasing them. This strategy allows investors to spread their gains over multiple years, making the most of the tax exemption limits and minimising their overall tax liability. By implementing tax harvesting, investors can optimise their tax planning efforts while maximising their investment returns in a tax-efficient manner.

Also Read: Your Questions Answered: How does tax-loss harvesting work and can it minimise my tax outgo?

Carry Forward Losses

Carry forward losses refer to business or investment losses that can be used to offset future profits for tax purposes. These losses are not immediately deductible but can be carried forward to reduce taxable income in future years, providing a valuable tax-saving strategy for individuals and entities.

When it comes to taxes, it's common to feel overwhelmed, especially if you've experienced losses in your investments. Let's consider a scenario where someone, let's call them Varun, incurred a loss of ₹1 lakh in the stock market. Feeling disheartened, Varun decides not to file a tax return, assuming that since he incurred a loss, he doesn't owe any taxes. However, this assumption is incorrect, and here's why: 

The Income Tax Act provides two important concepts: 

1. Set Off: Set off allows taxpayers to offset their losses against any profits they may have made in the same financial year. For instance, if Varun had any business or capital gains during the year, he could set off his losses against those gains, effectively reducing his taxable income. There are specific rules regarding which types of losses can be set off against which types of gains, such as long-term capital losses can only be set off against long-term capital gains, and so on.

Also Read: Is 80D Deduction the Only Way to Save Tax for Insurance Holders

2. Carry Forward: In cases where taxpayers have losses but no profits to set them off against, the Income Tax Act allows for the carry forward of losses. This means that Varun can carry forward his ₹1 lakh loss for up to eight years. If he earns profits in any of the subsequent years, he can offset those profits with the carried forward loss, thereby reducing his tax liability in those years.

However, here's the crucial point that Varun missed: In order to avail of the benefit of carry forward, it is imperative to file an income tax return. If Varun chooses not to file a return, he forfeits the opportunity to carry forward his losses, potentially missing out on significant tax benefits in the future.

Therefore, while incurring losses may seem discouraging, it's essential to understand the provisions of set off and carry forward provided by the Income Tax Act. By filing an income tax return and utilising these provisions effectively, taxpayers like Varun can minimise their tax burden and make the most of their investments in the long run.

Also Read: Income Tax Return: 5 lesser-known tax-saving tips from Section 80

In conclusion, tax harvesting and carrying forward losses are powerful strategies to optimise tax liabilities. Tax harvesting involves selling investments at a loss to offset gains, thereby reducing taxable income. Carry forward losses allow unused losses to be deducted from future gains, further reducing taxes. In conclusion, these tactics offer valuable opportunities for investors to manage their tax burdens efficiently while enhancing overall portfolio performance.

Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited