With the financial year 2025 coming to an end soon, investors and taxpayers are looking for ways to minimize their tax liability. One of the most effective methods to save tax on equity investments is tax loss harvesting. This strategy allows you to reduce capital gains tax legally by adjusting profits with losses. Here’s how you can use this method and other strategies to maximize your savings before the financial year ends.
What is Tax Loss Harvesting?
Tax loss harvesting is a technique where investors sell loss-making stocks to offset capital gains from profitable investments. This helps in reducing taxable income and lowering overall tax liability.
For example:
- If you have made a profit of ₹1 lakh from one stock and suffered a loss of ₹50,000 from another, you can adjust the loss against the gain. This will bring your net taxable gain to ₹50,000, thus reducing the tax burden.
Understanding Capital Gains Tax Rules
Short-Term vs. Long-Term Capital Gains
The tax rate on equity investments depends on the duration for which you hold the assets:
- Short-Term Capital Gains (STCG): If you sell stocks within 12 months, the gain is taxed at 20%.
- Long-Term Capital Gains (LTCG): If you hold stocks for more than 12 months, the first ₹1.25 lakh of profit is tax-free, and any amount above this is taxed at 12.5%.
How to Apply Tax Loss Harvesting?
1. Match Losses with Profits
- Short-term losses can be adjusted with both short-term and long-term gains.
- Long-term losses can be adjusted only with long-term gains.
2. Sell Loss-Making Investments
Identify stocks that are in loss and consider selling them to offset profits from winning investments.
3. Reinvest After Booking Loss
If you believe in the stock’s future growth, you can buy it again after selling it for loss booking purposes.
Example:
If you bought 100 shares at ₹5,000 per share and their price dropped to ₹4,000, you have a loss of ₹1 lakh. If you also booked a profit of ₹1 lakh from another stock, you can use this loss to save ₹20,000 tax on short-term capital gains.
Important Tax-Saving Actions Before 31st March
1. Review Your Portfolio
- Identify stocks that are in profit and loss.
- Sell loss-making stocks to offset taxable gains.
2. Book Long-Term Capital Gains Up to ₹1.25 Lakh
- Take advantage of the tax-free LTCG limit.
3. Carry Forward Losses for Future Use
- Unused losses can be carried forward for 8 years to offset future profits.
Precautions to Take While Applying Tax Harvesting
1. Follow the First In, First Out (FIFO) Rule
- When selling stocks, the ones bought first are considered as sold first.
- Check the holding period before selling to avoid unnecessary tax liability.
2. SIP Investors Should Be Careful
- If you invest through SIP, only units older than 12 months qualify for long-term capital gains tax.
- Selling all units at once might lead to short-term tax liability on newer units.
3. Brokerage and STT Considerations
- Every transaction includes a brokerage fee and Securities Transaction Tax (STT).
- However, the tax benefits from harvesting outweigh these costs.
Two Scenarios Explaining Tax Harvesting Benefits
Scenario 1: Without Tax Harvesting
Ramesh bought 100 shares at ₹5,000 per share in January 2024.
- In February 2025, the price rose to ₹6,250.
- By March 2026, the price further increased to ₹7,500.
- His total profit is ₹2.5 lakh, out of which ₹1.25 lakh is tax-free.
- Remaining ₹1.25 lakh is taxed at 12.5% = ₹15,625 tax liability.
Scenario 2: With Tax Harvesting
Raju followed a different strategy:
- He bought 100 shares at ₹5,000 in January 2024.
- Sold them in February 2025 at ₹6,250, making ₹1.25 lakh profit (tax-free).
- He reinvested in the same stock.
- By March 2026, the stock reached ₹7,500, giving another ₹1.25 lakh profit.
- Since he followed tax harvesting, his entire gain is tax-free, saving ₹15,625 compared to Ramesh.
Additional Strategies to Save Tax on Equity Earnings
1. Invest in Tax-Saving Mutual Funds (ELSS)
- Equity-Linked Savings Schemes (ELSS) offer tax exemption up to ₹1.5 lakh under Section 80C.
2. Use Tax-Free Dividends
- Companies distribute dividends from after-tax profits, making them tax-free in investors’ hands.
3. Opt for Indexation Benefit on Debt Funds
- If investing in debt mutual funds, indexation helps in reducing taxable gains.
4. Hold Stocks for Over One Year
- Long-term holdings help investors benefit from the ₹1.25 lakh tax exemption.
Final Words
By using smart strategies like tax loss harvesting, capital gain exemption, and ELSS investments, you can legally reduce your tax burden. Make sure to act before 31st March to maximize your savings for FY 2025.
