Can Losses Help You Save Taxes? | Tax Loss Harvesting

Preview of the Capital Markets

2020 was a roller coaster of a year. The year started with the biggest sell-off markets seen since the 2008 global financial meltdown due to the unfolding Covid crisis. Historically, volatility drives retail investors away from the markets. But work from home & Reddit threads drove flocks of investors to the capital markets. From Robinhood to Zerodha saw their fortune rise exponentially. 

The market saw its lowest point on 23rd March. While the economy slumped, the Square Root Shaped Recovery Theory kicked in. One of the biggest markets rallies the Indian markets have witnessed. Which meant portfolio’s swelled and a lot of retail investors booked profits. One may ask, now what?

As the financial year draws to an end, it presents a unique opportunity to save taxes on Capital Gains, and rebalance the portfolio. We help thousands of investors file taxes at Quicko. Often, we get asked, what are other avenues to save taxes beyond Chapter VI-A deductions. Tax-loss harvesting is one of the open public secrets. Most investors have heard about it, but don’t know how to take advantage of the same. So we decided to decode tax-loss harvesting for you.  

What is Tax Loss Harvesting?

Tax Loss Harvesting is a lesser-known way to save taxes for a trader or even a value investor. Currently, short-term capital gains (STCG) are taxed at 15% while long-term capital gains (LTCG) above Rs. 1 lakh are taxed at 10% without indexation. According to the Income Tax Department,

  1. Short Term Capital Loss (STCL) can be set off against both STCG and LTCG.
  2. Long Term Capital Loss (LTCL) can be set off against LTCG only. 

Taking advantage of this, one can liquidate unrealized losses, to set off Realized Capital Gains, in the above order.

Let’s look at how Tax Loss Harvesting works

Let us say, you have realised gains STCG 50,000 and LTCG 1,80,000. Effectively you are paying taxes on 50,000 @ 15% and 80,000 @ 10%.

LTCG Tax – 80,000 X 10% = 8,000

STCG Tax – 50,000 X 15% = 7,500

Total = 15,500

You also have some unrealized losses for the financial year, which can be set off against Capital Gains (if the position is liquidated). Usually, we sell our shares on a FIFO basis (first-in-first-out).

This means that shares purchased first will be liquidated first.

tax loss harvesting step 1

As we can see, by selling the shares purchased on 12/12/2018, you would end up paying more taxes as you are selling the shares on a profit. 

LTCG Tax = (940 – 540) x 20 = Rs. 8000

Total LTCG Tax is now 1,88,000

Which further increases your tax liability by 8,000

tax loss harvesting step 2

By liquidating shares bought on 10/12/2020, you will book a loss of 60,000

LTCG Tax = (940 – 1,000) x 1000 = Rs. (60,000)

This LTCL (Long Term Capital Loss) is set off against LTCG. LTCG is now 1,58,000

Which reduces your Capital Gains by 52,000

tax loss harvesting step 3

Further, by liquidating shares bought on 10/01/2021, you will book a loss of 1,000

STCL  = (940 – 960) x 2000 = Rs. (40,000)

This STCL (Short Term Capital Loss) is first set off against STCG and if any losses remain, they will be set off against LTCG.

STCG is now 10,000 & LTCG Tax is now 1,28,000

tax loss harvesting step 4

So finally, your tax liability is

LTCG Tax – 28,000 X 10% = 2,800

STCG Tax – 10,000 X 15% = 1,500

Total = 4,300

You end up reducing your tax liability by 10,700 (15,000 – 4,300)

Rebalancing your Portfolio

A common question arises while practicing Tax Loss Harvesting. Why liquidate a position if I am bullish on that position? The answer is simply to book your losses and set it off against your realised gains. In American and European markets, A wash sale occurs when an investor sells or trades a security at a loss, and within 30 days before or after, regains that position or buys another one that is substantially similar, for the purpose of evading taxes. No such rule exists in India. However, one may look at this as an opportunity to rebalance their portfolio. 

Tax loss harvesting may differ depending on your situation so if you are not sure, consult a tax professional. 

You can also use a prototype Tax Loss Harvesting Simulator that we have built

Tweet to us & let us know if you would like us to build this feature.

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