Sell, buy back and save: Here's how tax harvesting can maximise your returns

Taxation is an essential aspect of financial planning, yet many investors overlook the impact of capital gains tax on their investments. Most individuals focus on income tax deductions but fail to account for the taxes levied on their stock market and mutual fund gains.

Since capital gains tax is not deducted at source like salary income, investors need to proactively manage their investments to avoid unnecessary tax burdens. This is where tax harvesting comes in—a smart and legal method to reduce taxable gains, optimise tax liability, and maximise net returns.

Tax harvesting involves selling underperforming or loss-making investments to offset capital gains and reduce the overall tax payable. It is a strategic approach widely used in global markets, and Indian investors can also leverage it to lower their tax outflow while reinvesting in similar assets to continue growing their wealth. Whether you invest in stocks, bonds, mutual funds, or ETFs, understanding how to efficiently manage capital gains tax can have a significant impact on long-term wealth creation.

Categories of capital gains tax

Long-term capital gains (LTCG): Applicable when investments are sold after 12 months of purchase. The tax rate is 12.5 percent on gains exceeding Rs 1.25 lakh.

Short-term capital gains (STCG): Applicable when investments are sold within 12 months. The tax rate is a flat 20 percent on the entire gain.

Tax harvesting versus no tax harvesting

Scenario 1: Without wax harvesting

For example, consider an investor, Raj, who bought the following stocks and mutual funds:

• Invested Rs 50 lakh in Stock A in January 2022. By March 2025, the value grew to Rs 70 lakh, leading to a gain of Rs 20 lakh.
• Invested Rs 30 lakh in Mutual Fund A in January 2022. By March 2025, the value grew to Rs 45 lakh, leading to a gain of Rs 15 lakh.Total LTCG = Rs 20 lakh (Stock A) + Rs 15 lakh (Mutual Fund A) = Rs 35 lakh

Raj pays Rs 4,21,875 in tax on his long-term gains.

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Scenario 2: With tax harvesting

Now, Raj actively monitors his portfolio and notices that one of his investments is in a loss:

Invested Rs 20 lakh in Stock B in January 2022. By March 2025, the value dropped to Rs 12 lakh, incurring a loss of Rs 8 lakh.

He books this loss momentarily but buys Stock B shares the next day, ensuring that he books his losses and retains his stock holding as well.

Revised taxable LTCG = Rs 33.75 lakh - Rs 8 lakh = Rs 25.75 lakh, revised LTCG tax = 12.5 percent of Rs 25.75 lakh = Rs 3,21,875.

Alternatively, Raj can reinvest the entire amount back into a similar stock or mutual fund as a lump sum, ensuring that his investment remains in the market while benefiting from tax savings.

Total savings from tax harvesting

Without tax harvesting: Rs 4,21,875 tax payable

With tax harvesting: Rs 3,21,875 tax payable

Total tax saved: Rs 1,00,000

Tax harvesting: A practical scenario

Let's understand how tax harvesting works in a wider portfolio with this example.

Mr Sharma's total LTCG of Rs 5,12,861 is taxable beyond the Rs 1,25,000 exemption. Using tax harvesting, he offsets Rs 1,43,104 Short-Term Capital Loss (STCL) and Rs 1,86,000 Long-Term Capital Loss (LTCL), reducing taxable LTCG to Rs 58,757.

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Final action plan

• He sells loss-making stocks (E & F) before March 28, 2025, to book a loss of Rs 3,29,104.
• Offset losses against LTCG, reducing taxable gains from Rs 3,87,861 to Rs 58,757. STCL can be set off against both STCG and LTCG. LTCL can be set off only against LTCG. Unused losses can be carried forward for 8 years.
• Reinvest the proceeds into similar stocks or mutual funds to maintain portfolio exposure.
• Ensure transactions are completed before the financial year ends to claim tax benefits.

Tax harvesting is an effective strategy to minimise tax liability by offsetting capital gains with losses, allowing reinvestment for compounding and carrying forward unused capital losses for up to 8 years. However, it requires active monitoring, comes with transaction costs, and may not be beneficial if the market recovers after selling loss-making investments.

Despite these risks, tax harvesting can help investors optimise their returns and legally reduce taxes, making it a useful tool for financial planning. By systematically managing gains and losses, investors can enhance their post-tax returns and make the most of their investment portfolios.

The writer is a Certified Financial Planner and Founder, True North Finance, a financial and investment planning firm based in Pune.

Disclaimer: The views expressed by experts on Moneycontrol are their own and not those of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.