Tax Harvesting is a powerful strategy that can help save tax and help you clean jum in your portfolio. In this complete guide, I will unveil the secrets of tax harvesting mutual funds. Whether you are an experienced investor looking to boost your returns or a beginner seeking to optimize your tax efficiency, this guide is your ultimate resource. I will break down the concept of tax harvesting, explain how it works, and when you should use this strategy. With the help of this guide, you will be equipped with the knowledge to make informed decisions and take control of your tax savings.
Table of Contents
What is Tax Harvesting?
Tax harvesting, also known as tax-loss harvesting, is a strategy investors use to maximize their tax savings by strategically selling investments that have experienced losses. In the context of mutual funds, tax harvesting involves identifying and selling mutual fund units that have declined in value to generate capital losses, which can be used to offset capital gains or reduce taxable income.
The basic principle behind tax harvesting is to sell investments that have declined in value and use the resulting losses to offset capital gains, thereby reducing the overall tax burden. Tax harvesting allows investors to save on taxes and potentially increase their after-tax returns.
What are Capital Gains?
Before we discuss tax harvesting, it is essential to understand capital gains.
Any gain from selling a capital asset is known as a capital gain. However, if a loss arises from the sale of a capital asset is known as a capital loss.
There are two types of Capital Gains
- 🔹Short-term capital gain (STCG)
- 🔹Long-term capital gain (LTCG).
Any capital gain arising from the sale of capital assets can be identified as STCG or LTCG based on the type of capital asset and its holding period. As in this article, we are discussing Tax Harvesting Mutual Funds; hence, we will limit the category to Equity & Debt.
Taxation of Capital Gains of Equity and Debt Funds is based on its holding period:
| Capital Asset Type | Short Term Capital Gain (STCG) | Long Term Capital Gain (LTCG) |
| Equity | Less than 12 months | More than & equal to 12 months |
| Debt | Less than 36 months | More than & equal to 36 months |
Any mutual fund scheme holding 65% of equity or more is considered under equity fund, and if otherwise, then debt fund.
Here is the table that depicts your tax liability on capital gain based on fund category:
| Fund Category | Short Term Capital Gain (STCG) | Long Term Capital Gain (LTCG) |
| Equity Funds | 15% of Capital gain | Capital gain up to Rs 1 lakh every financial year is tax-free. Any gains above Rs 1 lakh are taxed at 10% |
| Debt Funds (Equity Holding: Less than 35%) | Capital gain is taxed at the investor’s income tax slab rate | Capital gain is taxed at the investor’s income tax slab rate |
| Debt Funds (Equity Holding: Between 35% to less than 65%) | Capital gain is taxed at the investor’s income tax slab rate | 20% of Capital gain with indexation benefit |
📖 Related Read Debt Mutual Funds Taxation New Rule effective 1st April 2023
What is the Rule – Capital Losses Set off?
The IT department clearly defines that capital gain loss can be set off against the head capital gains only.
- 🔹Long-term capital loss can be set off against long-term capital gain only.
- 🔹Short-term capital loss can be set off against long-term gain or short-term capital gain.
What is the Rule – Carry Forward of Losses?
As per IT rule, assess can carry forward both long-term capital and short-term loss for 8 AY (assessment years) immediately following the AY in which the loss was first computed and can be set off against capital gain only.
How Tax Harvesting Mutual Funds Work?
Now you know what capital gain, capital loss, and set off of the capital losses rule are.
Let’s understand how tax harvesting in mutual funds works with an example.
Suppose you have invested in two mutual funds schemes: Scheme-A, which has a capital gain of Rs. 1,00,000, and Scheme-B, which has a capital loss of Rs. 50,000.
If you were to sell both schemes, you would have a net capital gain of Rs. 50,000 (Rs. 1,00,000 – Rs. 50,000). However, by employing tax harvesting, you can sell all scheme-B units (investment making the loss) to realize the capital loss and sell part of scheme-A units to book the capital gain of Rs. 50,000 only to set off the loss realized from Scheme-B. This would reduce your taxable gain to zero, resulting in potential tax savings.
Remember:
For tax harvesting to work for you, please immediately (same-day) invest the redemption amount back in the fund. For a mutual fund, the redemption process can take three days, and the NAV can surely change by that time. You will incur a loss if the NAV goes up. Hence, you must have an excess amount readily available in your bank account to re-invest before the cut-off time the same day.
When Should You Consider Tax Harvesting?
Tax harvesting should not be considered an investment strategy or solely with the intention of tax saving.
Tax harvesting can be considered in the two scenarios:
- Fund not performing well: It may happen that any of the funds you have invested are not performing well and are at a loss for quite some time. At the same time, you can consider tax harvesting.
- Rebalancing: Consider tax harvesting when rebalancing (if your funds are not performing well). Or else, consider increasing the debt portion with a fresh investment (for example- bonus received) to rebalance rather than selling-equity holding.
A detailed study by value research clearly shows that the difference in the returns (IRR) for the two below scenarios is about 0.29% only.
Scenario-1: The investor keeps investing through this period and does nothing to harvest tax.
Scenario-2: The investor actively deploys the tax-harvesting strategy every year.
Hence, tax harvesting as an investment strategy is not a good idea.
Conclusion
Tax harvesting is one of the strategies to maximize your saving; beneficial for tax saving purposes only (may impact your financial goals) and may need tax expert help. Doing it every year is not a good idea at all. It’s not wise to use tax harvesting as an investment strategy or solely with the intention of tax saving. Rather, focus on disciplined and goal-based investing to help you achieve your financial goals on time and live a peaceful financial life.
Frequently Asked Questions
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