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How to use equity loss to reduce tax liability

Here is a simple way to use already accrued losses to save your tax outflow. You can use your equity capital loss to off set gains from debt mutual funds, gold or real estate.

March 04, 2009 / 12:31 PM IST

Every dark cloud, they say, has a silver lining. For investors who have lost heavily in the recent Indian equity market crash, it would seem rather difficult to believe this. While little can be done about the actual losses that you may have suffered, there is a way to use them to reduce your income tax liability on other gains. Let us look at one such method in this article.

A brief excursion into the relevant tax rules would be in order first. Long term capital losses can be set off only against long term capital gains. However, short term capital losses can be set off against both short term and long term capital gains. In the context of listed shares and mutual funds (both debt and equity), a period of over one year is long term, and anything less than that is considered short term. The corresponding time period for real estate and gold is three years.

For easy reference, let us put down the currently prevailing short term and long term capital gains tax rates for each of these categories below:

Asset class

Short-term capital gains tax rate

Long-term capital gains tax rate

Listed shares

15%

0%

Equity mutual funds

15%

0%

Debt mutual funds, FMPs

33.6%

Lower of 10% non-indexed or 20% indexed

Real Estate

33.6%

20% indexed

Gold

33.6%

20% indexed

 

 

 

 

 

Of course, all these capital gains accrue when the asset is sold or transferred out.

The central theme of the idea is to use the equity market downturn to book short term capital losses. And then utilise these booked losses to set off long term or short term capital gains on gold, real estate or debt fund portfolios.

Let us look at this theme in more detail through an example. You may note that in this example, we have not taken any view on the portfolio allocation strategy per se. For instance, to determine whether you are over-weight on real estate or under-weight on equity, etc, a closer analysis of your individual portfolio is called for. Rather, we are only looking at a general strategy you can adopt to minimise tax liability within the boundaries dictated by your portfolio allocation strategy.

Assume you had a portfolio over Rs 10 lakh of investments in shares or mutual funds. Most of these investments were done late in 2007 or in early 2008. After the market crash, you find yourself looking at a portfolio value of only Rs 7 lakh today. Assume you have decided to weather this downturn and hold on to equity portfolio, either because you are willing to wait for the next up-cycle, or because your portfolio allocation suggests that. If you simply hold on to your shares, and they again rise to Rs 10 lakh in two years time, you would have squared off your losses. There would be no capital loss (or gain) that you would have. Thus, if you have any other capital gain this year

first published: Mar 3, 2009 04:58 pm

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