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Everything to know about Tax Gain Harvesting

While a lot is talked about Tax Loss Harvesting, not much is spoken about Tax Gain Harvesting. It is the practice of Harvesting your gains…especially your Long Term Capital Gains to save up to INR 10,000 in taxes every year. So how does this actually work? Let us find out

Understanding Taxation

Now, before proceeding with Tax Gain Harvesting, we need to understand the fundamentals of Long Term Capital Gain Tax

  • Long Term Capital Gains (LTCG) are taxed at 10% rate when STT is paid.
  • However, there is an exemption on LTCG Tax. The First Rs 1 lakh of LTCG when STT is paid is tax-free. Gains above INR 1 lakh will be taxed at 10% per year

    For example
    Your LTCG for the year is INR 2,00,000
    So, your taxable Income will be INR 2,00,000- INR 1,00,000: INR 1,00,000
    And, your taxability at 10% rate will be 10% of INR 1,00,000 : INR 10,000

So, what is Tax Gain Harvesting

Tax Gain Harvesting works by selling your profit-making securities and realising a Long Term Capital Gain of up to INR 1,00,000 in a Financial Year.

However, you will not have to pay any LTCG tax on your booked profits since it will be under INR 1lakh. So, now you reinvest the total amount i.e your initial capital + your profits back to maintain the portfolio.

As we already mentioned, by practising Tax Gain Harvesting you can save up to INR 10,000 every year. However, you will be able to enjoy this benefit only after your final exit from the market. 

There’s another way of Harvesting your gains and here the motive is to utilise the losses that can’t be carried forward.

As we all know that we can’t carry forward our losses for more than 8 years. So suppose you have certain losses that you can no more carry forward. To utilise those losses, you can choose to sell some profit-making securities in your portfolio and set off your losses against the realised gains to optimise your tax liability. 

You can harvest your Capital Gains to set off your F&O losses in the current year as well.

However, today we will be mostly talking about the first way of Tax Gain Harvesting.

Things to remember about Tax Gain Harvesting

There are certain factors that we need to consider before opting for Tax Gain Harvesting

  • In order to maintain continuity of investment, you need to reinvest in the market as soon as you redeem the older units for tax gain harvesting. However, it can be a challenge to buy back stocks or mutual funds at the same price at which you sold them, since prices change every second.
  • You need to have enough liquidity to reinvest quickly in the market . This is because settlement takes T+2 days.

Breaking down Tax Gain Harvesting with an example

So, for this example, consider yourself as an investor who has made an initial investment of INR 8,00,000 in an equity mutual fund in February 2019.

LTCG Tax Liability without Tax Gain Harvesting

Year 1
In March 2020 the value of your investment goes up to INR 8,50,000
So, your unrealised LTCG stands at INR(8,50,000-8,00,000) : INR 50,000.
You don’t realise your profit and stay in the Market.

Year 2
In March 2021, the value of your investment becomes INR 9,50,000
So now, your unrealised LTCG is INR(9,50,000-8,00,000) : INR 1,50,000.
Since your gain is unrealised, you do not have any Tax Liability.

Year 3
In March 2022, the value of your investment becomes INR 12,50,000.
So now, your unrealised LTCG is INR(12,50,000-8,00,000) : INR 4,50,000.

However, this time you decide to realise your gain and you sell your investment. So, as of March 2022, you have a realised LTCG of INR 4,50,000.

So, your Net Taxable income will be
INR 4,50,000 – INR 1,00,000 = INR 3,50,000

Accordingly, your LTCG tax liability will be
10% of INR 3,50,000 = INR 35,000.

So, after 3 years, will be having LTCG tax liability of INR 35,000

LTCG Liability with Tax Gain Harvesting

So, let us now understand the same scenario, with Tax Gain Harvesting

Year 1
In March 2020 the value of your investment goes up to INR 8,50,000
So, your unrealised LTCG stands at INR(8,50,000-8,00,000) : INR 50,000.

However, now you decide to Harvest your Gains. You Sell your investment and realise a gain of INR 50,000.

Your LTCG Tax liability is nil since the gain is less than INR 1,00,000.

You then reinvest the entire amount i.e INR 8,00,000 + INR 50,0000 = INR 8,50,000 back in the market.

However, the buying price now is INR 8,50,000

Year 2

In March 2021, the value of your investment becomes INR 9,50,000
Now, your unrealised LTCG is INR(9,50,000-8,50,000) : INR 1,00,000.

You again decide to harvest your gains of INR 1,00,000 by selling your investment

You now have a realised LTCG of INR 1,00,000. However, the Tax liability is again nil owing to the exemption limit of INR 1,00,000

You reinvest the entire amount of INR 8,50,000+INR 1,00,000 = INR 9,50,000
back in the market.

The INR 9,50,000 now becomes the new buying price

Year 3

In March 2022, the value of your investment becomes INR 12,50,000.
So now, your unrealised LTCG is INR(12,50,000-9,50,000) : INR 3,00,000.

Now, you decide to realise your entire profit and exit the market.

So now, your realised LTCG is INR 3,00,000.
Your Net Taxable Income will be INR 3,00,000 – INR 1,00,000 : INR 2,00,000

Accordingly, your LTCG tax liability will be
10% of INR 2,00,000 = INR 20,000.

So, at end of 3 years, you were able to save INR 15,000 with Tax Gain Harvesting, while enjoying the same returns.

So, will Tax Gain Harvesting become a part of your investment strategy? Share your thoughts with us.

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