Dealing with taxes can be overwhelming, especially for individuals who are unfamiliar with the intricacies of tax laws. Last year's budget was full of surprises for almost every industry. FM Nirmala Sitharaman announced a surge in capital gains tax slabs. Both LTCG (Long-term capital gains) and STCG (Short-term capital gains) increased from 10% and 15% to 12.5% and 20% respectively.
However, there are several strategies to optimize your Capital gain tax liability, and one powerful method is tax loss harvesting. This comprehensive guide will help you understand how tax loss harvesting works, its benefits, and how it can be applied, including for NRIs.
Tax loss harvesting is a strategy to reduce your capital gains tax liability. It involves selling underperforming or loss-making investments and using the realized loss to offset gains from other investments. This approach can be applied to both short-term and long-term capital gains.
The process of tax loss harvesting involves several steps.
First, you need to identify investments in your portfolio that are underperforming and have unrealized losses. Once you have identified these assets, you sell them to realize the loss. This loss can then be used to offset gains from other investments, reducing your overall taxable income.
After realizing the loss, you can reinvest the proceeds into a similar or different asset to maintain the desired portfolio allocation. This ensures your investment strategy remains on track while optimizing taxes.
It is important to remember that short-term losses can offset both short-term and long-term gains, whereas long-term losses can only offset long-term gains.
Note: If you buy and sell stocks on the same day, it’s considered intraday trading, not delivery-based trading. This means any loss incurred will NOT be recognized under Short-Term Capital Gains (STCG) for tax purposes.
NRIs investing in India can also take advantage of tax loss harvesting to optimize their tax liabilities. Under Indian tax laws, NRIs are subject to short-term capital gains tax at 20% and long-term capital gains tax at 15% for gains exceeding ₹1 lakh.
By identifying underperforming investments in their Indian portfolio, NRIs can sell these assets to realize losses and offset gains from other investments.
One critical regulation to keep in mind when engaging in tax loss harvesting is the wash sale rule, particularly for NRIs who file taxes in countries like the United States. The IRS prohibits claiming a loss on a wash sale, which occurs when you sell a security at a loss and then repurchase the same or a "substantially identical" security within 30 days of the sale. This rule applies to all accounts under your name, including IRAs and spousal accounts.
For example, if you sell shares of Company A at a loss and then repurchase those shares within the 30-day window, the loss would be disallowed for tax purposes. Similarly, if your spouse buys the same stock within this period and you file joint returns, the wash sale rule would still apply. This regulation ensures that investors do not exploit tax loopholes by quickly reinvesting in the same asset.
To avoid triggering a wash sale, consider these strategies:
Invest in similar but not identical securities. For instance, instead of repurchasing shares of a specific technology company, invest in another technology-focused company.
Wait out the required 30-day period before repurchasing the same security.
Failure to adhere to the wash sale rule could lead to complications in tax reporting and penalties, so meticulous record-keeping is essential.
NRIs must also comply with Indian tax regulations, such as filing an income tax return and adhering to provisions under the Double Taxation Avoidance Agreement (DTAA) if applicable. By doing so, they can maximize their tax savings while ensuring legal compliance.
Tax loss harvesting offers several advantages, including significant tax savings and improved portfolio management. By reducing taxable capital gains, investors can lower their tax liability and reinvest the saved amount into their portfolios. This allows for better portfolio optimization, as underperforming assets are replaced with investments aligned with financial goals.
Additionally, tax loss harvesting can defer tax liabilities to future years, providing a time-value benefit. It also enables cross-asset optimization, as losses from one asset class can offset gains from another.
Let’s say Arjun has earned ₹1,00,000 in short-term capital gains during the financial year, which would typically attract a 20% tax of ₹20,000. To reduce his tax liability, Arjun identifies loss-making stocks in his portfolio with an unrealized loss of ₹60,000. By selling these stocks, he realizes the loss and offsets it against his short-term gains. And then buy the same stock again—keeping the same quantity. This reduces his taxable gain to ₹40,000, and the tax liability drops to ₹8,000.
As a result, Arjun saves ₹12,000 in taxes.
Now consider that Arjun also has ₹5,00,000 in long-term capital gains from stocks held for over a year. The tax liability on this gain is ₹60,000 (15% of ₹4,00,000, after exempting the first ₹1,00,000). To reduce this, Arjun identifies long-term loss-making stocks worth ₹3,00,000. By selling these stocks, he realizes the loss and offsets it against his long-term gains, reducing the taxable gain to ₹2,00,000. After the ₹1,00,000 exemption, only ₹1,00,000 is taxable, resulting in a tax liability of ₹15,000.
This saves Arjun ₹45,000 in taxes.
These examples demonstrate how tax loss harvesting can significantly lower tax liabilities while optimizing portfolios.
While tax loss harvesting is a valuable tool, there are important considerations to ensure its effectiveness. Investors must also complete tax loss harvesting before the end of the financial year (31st March) to claim the benefit for that year.
Additionally, the strategy should be used only as a tax optimization tool.
Risk management is crucial when reinvesting proceeds from loss-making trades. It is essential to avoid unnecessary risks and ensure that the reinvested assets align with your long-term financial goals.
Tax loss harvesting is not inherently risky, as it involves selling underperforming assets. However, reinvestment should be carefully planned to avoid unnecessary risks.
No such deadline as it’s a voluntary process. But to get its benefit you must do it before 31st March, before filing your income tax return.
Yes, NRIs can reduce their capital gains tax liability on Indian investments by utilizing tax loss harvesting strategies. But have to keep certain points regarding Wash sales.
Are all types of losses eligible for tax loss harvesting?
No, Short-term capital losses can offset both long-term and short-term capital gains, while long-term losses can offset long-term gains only.
Can I carry forward losses indefinitely?
Long-term and Short-term capital losses can be carried forward for up to eight years.
