When people think about taxes in India, they often focus on those applied to salary or business income. While most are aware of tax slabs and exemptions, investment-related taxes are frequently overlooked.

Capital gains from investments aren’t deducted at source like salary taxes, meaning investors must actively manage their portfolios to calculate tax liabilities. Without proper planning, they may end up paying more than necessary.

What is Tax Harvesting?

Tax harvesting is a strategy to minimize tax liabilities by selling underperforming stocks or mutual funds to offset capital gains. This approach is particularly beneficial for investors who have earned significant returns.

Capital Assets and Capital Gains Tax

Capital assets include investments such as land, buildings, stocks, jewelry, bonds, and mutual funds. The tax on profits from selling these assets is known as capital gains tax. This article focuses on capital gains taxation related to equity shares, preference shares, debentures, government securities, bonds, and mutual funds.

Capital gains tax is classified into two types based on the holding period:

1. Long-Term Capital Gains (LTCG) Tax

• Applies to investments sold after 12 months.
• Investors pay 12.5% tax on profits exceeding ₹1.25 lakhs.

Example:

You invest ₹5 lakhs in a stock. After 2 years, its value rises to ₹6.5 lakhs, resulting in a ₹1.5 lakh gain. Since ₹1.25 lakhs is tax-free, the taxable amount is ₹25,000. You will pay ₹3,125 (12.5% of ₹25,000) as LTCG tax.

2. Short-Term Capital Gains (STCG) Tax

• Applies to investments sold within 12 months.
• A flat 20% tax is charged on profits, regardless of the amount.

Example:

You invest ₹1 lakh in a stock on 30 April 2023 and sell it for ₹1.5 lakhs on 31 December 2023. Your profit of ₹50,000 is taxed at 20%, resulting in ₹10,000 as STCG tax.

How to Reduce LTCG Tax Liability

1. Sell Before Gains Exceed ₹1.25 Lakhs

Since LTCG below ₹1.25 lakhs is tax-free, investors can sell their investments strategically.

Example:

You invest ₹5 lakhs in January 2022. By March 2023, the investment grows to ₹5.6 lakhs. Selling at this stage results in a ₹60,000 gain, which is tax-free.

What If LTCG Exceeds ₹1.25 Lakhs?

If you hold the investment until it grows to ₹7 lakhs, your capital gain becomes ₹2 lakhs. The taxable portion is now ₹75,000, leading to ₹9,375 in taxes (12.5% of ₹75,000).

2. Offset Losses with Gains (Tax-Loss Harvesting)

Investors can reduce tax liability by offsetting losses against gains.

Example:

You invest ₹1 lakh in a stock in 2021. By 2023, its value drops to ₹80,000, creating a ₹20,000 loss. If you sell, this loss can be used to offset long-term capital gains from another investment.

If another stock gives a ₹1.5 lakh LTCG, you would normally pay tax on ₹25,000 (profit exceeding ₹1.25 lakhs). However, by offsetting the ₹20,000 loss, the taxable gain reduces to ₹5,000, significantly lowering the tax burden.

Reducing STCG Tax Liability

Since STCG is taxed at 20% irrespective of profit size, it cannot be avoided. However, losses can be used to reduce taxable gains.

• Long-term capital losses can only be set off against long-term capital gains.
• Short-term capital losses can be used against both short-term and long-term gains.
• Unused losses can be carried forward for up to 8 years to offset future gains.

Key Takeaways

Tax-loss harvesting is an effective strategy for stock market investors looking to maximize returns while minimizing tax liability. Since it requires continuous monitoring, investors must stay proactive. By reinvesting the redeemed amount, they can continue compounding returns while reducing tax impact.

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