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What is tax loss harvesting?

Tax-loss harvesting is the practice of selling a security that has experienced a loss. By realising or "harvesting" a loss, investors can reduce or offset taxes on any capital gains income on which a tax is applicable. The sold security can either be bought back or replaced by a similar one.

Example scenario

  1. Assume ₹1 lakh in Short-Term Capital Gains (STCG) is made this year. 15% of this must be paid as taxes,i.e., ₹15000.
  2. Also, assume that stocks having an unrealized loss of ₹60,000 are held. These stocks can be sold to reduce the net STCG to ₹40,000. Hence 15% of ₹40,000 or ₹6,000 must be paid as taxes  – saving ₹9,000 in taxes.

This exercise lets the clients harvest the losses and save on taxes, hence called tax-loss harvesting.

While there is no explicit regulation in India that disallows tax loss harvesting. In the US, if stocks are sold and bought back within 30 days just to reduce taxes on realised gains, they are called wash sales, and taxes are disallowed to be offset. It is advisable for clients trading and investing in India to consult a Chartered Accountant (CA) while filing income tax returns, as they could potentially be questioned by the income tax authorities during tax scrutiny if the same stock is sold and bought back to save on the taxes.

A report of the tax-loss harvesting opportunity in the Zerodha account can be accessed by visiting console.zerodha.com/reports/tax-loss-harvesting/eq.

Visit zerodha.com/varsity/module/markets-and-taxation/ to learn everything about taxation when trading or investing.

To learn more about how this strategy can be used to plan taxes, visit zrd.sh/tax-loss-harvesting-22.

Did you know?

  • The buy average and P&L in Console is calculated based on the FIFO (First In First Out) method. If a stock which is under short term loss and long-term profit is held, the entire holding must be sold to book the short term capital loss. This will, however, book the long term capital gains in the stock as well.
  • While computing the long term capital gains and its harvest opportunity, the first ₹1 lakh of long-term gains is tax-free. This is not considered in the tax-loss harvesting report on Console.
  • When there are no realised profits, or if realized losses are greater than the realized profits, there will be no tax-loss harvesting opportunity.
  • It is advised to verify the buy average and P&L before deciding to sell. It is best to take the help of a CA.