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With big gains on mutual fund investments, comes the pain of paying taxes on them. Capital gains earned over and above 1 lakh on selling equities is taxed at 10%. However, with proper planning, the same can be reduced significantly.  

Use these two methods to reduce taxes on your capital gains:

Redeem to reinvest: Let’s suppose in a particular year, you made 4.9 lakh from a mutual fund investments of 4 lakh. Now, you redeem the entire amount, and invest it again. The following year, the total corpus becomes 5.6 lakh, i.e. gains worth 70,000. 

Now, in case, you would not have redeemed and reinvested, the capital gains would be 1.6 lakh, of this 60,000 would be taxable.

The method of redeeming mutual fund investments to reinvest further to reduce taxes is called tax harvesting.  However, it is extremely essential to reinvest the money immediately. Otherwise, if the money lies idle in the bank, it will get spent or invested unfavourably, that way the strategy loses its purpose.

Tax loss harvesting: Another excellent strategy to reduce taxes, through this method, capital loss in a particular year can be used to adjust taxable capital gains, says Amit Trivedi, personal finance coach and author of Riding the Roller Coaster.

Further explaining how the method works, he says, “Let us say that in a year, one incurred capital gains worth 2,50,000 from a particular equity mutual fund investment. And for this, the taxable capital gains would be 1,50,000."

“At the same time, he incurred capital loss worth 1,20,000 from another fund in the same year. Then, this loss would be adjusted against the taxable capital gains of 1,50,000 from the previous fund."

Thus one arrives at net capital gains worth 30,000, on which the tax would be payable, he adds. 

Moreover, the unabsorbed losses for a particular financial year could be carried forward for 8 years to reduce tax on capital gains even in subsequent years, says Renu Maheswari, Renu Maheshwari, SEBI registered investment advisor, CEO, and principal advisor at Finzscholarz.

That is, suppose you incurred a capital loss of 40,000 in 2018, and booked capital gains worth 1.8 lakh in 2020. While calculating the taxes for 2020, you can remove 40,000 from 1.8 lakh and that way the amount taxable would be 40,000.

“This can be done in debt and equity funds alike. This is a good technique to take advantage of lows in the market and reduce tax outgo," says Renu Maheswari, financial advisor and founder, Finolarchz. 

This method can increase the net returns on the portfolio. The best thing is that even a bad year can add to the value of the portfolio, concludes Maheswari.

 

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