Is your investment portfolio in the red? The answer is probably yes. Stock market downturns can be painful and disheartening, but there is a silver lining that seasoned investors often use to offset their losses: tax-loss harvesting. This strategy allows investors to turn their losses into potential tax benefits, but it must be done before the financial year ends.
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What exactly is tax-loss harvesting, and how does it work? How can you use it to offset your losses from trading or mutual funds? Let’s understand the fine print of tax-loss harvesting and explore how to make the most of it.
What is Tax-Loss Harvesting?
Tax-loss harvesting is a financial strategy in which you sell investments at a loss and use that loss to offset gains in other investments. This effective strategy reduces the amount you would owe on capital gains and lowers the tax you will pay on them.
How Does Tax-Loss Harvesting Work?
In India, you are liable to pay capital gains tax on profits booked from your equity funds or stocks every financial year. The tax rate depends on whether your capital gains are short-term or long-term.
If you have held a stock or mutual fund for 12 months or less from the date of purchase, the gains you realise are classified as short-term capital gains (STCG) and taxed at 20%. If you have held a stock or mutual fund for over 12 months, the gains will be treated as long-term capital gains, taxed at 12.5%. Remember that up to Rs 1.25 lakh of long-term capital gains in a financial year is exempt from tax.
You only pay capital gains tax on your net capital gains. If you book capital losses on your equities and have capital gains from other similar income, you can offset those losses against gains to calculate your tax liability. Keep in mind that the set-off rule applies only to losses you realise, not to notional losses. Therefore, to set off losses, you need to sell your investments before the financial year ends.
Let’s put some numbers behind tax-loss harvesting to demonstrate how it can help you save.
Suppose you have long-term capital gains of Rs 5 lakh and short-term capital gains of Rs 2 lakh. Now, you see unrealised capital losses of Rs 3 lakh on your long-term holdings. If you book that loss before March 31, 2025, you will need to pay tax only on Rs 4 lakh capital gains instead of Rs 7 lakh earlier.
Tax-Loss Harvesting: Can You Set Off Your Trading Loss Against Gains from Mutual Funds?
At this point, you must be excited to offset your trading losses with the profits earned from long-term mutual fund holdings. But wait a minute. It is important to understand that incomes from different transactions are classified differently for tax purposes. Intraday trading is treated as a speculative business, while F&O (Futures and Options) is classified as a non-speculative business and taxable under the heading ‘Profits or Gains from Business’. The profits made from stocks and mutual funds are considered capital gains.
Now, let’s understand the rules for setting off losses. Non-speculative losses can be offset against any other income category except salary within the same financial year. This includes capital gains from stocks and mutual funds. So, if you incur a loss from F&O trades, you can offset that loss against capital gains on stocks and mutual funds in the same financial year. Speculative or intraday losses can only be offset against intraday profits.
Duration of Tax-Loss Harvesting: How Long Can You Offset Losses Against Gains?
For different kinds of losses, there is a timeline by which you can carry them forward and adjust them against other income or gains. For example, short-term capital losses can be adjusted against both short-term and long-term capital gains. Your losses will first be offset against income in the current financial year, and any remaining losses can be carried forward for up to eight assessment years. In the case of long-term capital losses, they can only be adjusted against long-term capital gains and can also be carried forward for eight assessment years. Speculative business losses can be adjusted against speculative business gains and can be carried forward for four assessment years.
Can You Opt for Tax-Loss Harvesting Even If You Choose the New Tax Regime?
Yes. Tax-loss harvesting is allowed in both old and new tax regimes for the financial year 2024-25.
Two Key Points That You Need to Remember About Tax-Loss Harvesting
1) Firstly, you need to file your income tax return by July 31, 2025, if you want to take advantage of tax-loss harvesting. You won’t be able to benefit from it if you don’t file your income tax return for the financial year 2024-25 before the due date.
2) You have to sell your investments before the financial year ends to set off losses against gains from other investments. As the stock market will remain closed on March 29 and March 30 due to the weekend and for Id-Ul-Fitr on March 31, 2025, take your investment-related decisions by March 28, 2025.
If you find it difficult to do it yourself and are stuck in the procedure, consult a Qualified Financial Advisor to help you. It is advisable to consult a professional while filing income tax returns to avoid misinterpretation of laws and to prevent subsequent penalties.
