Tax-saving strategies are essential to preserving your investment returns, and tax harvesting is one highly-effective method. It involves strategically selling mutual fund units to reduce your capital gains tax liability. Here’s how it works and why it’s beneficial.
Understanding Capital Gains and Taxation:
Before diving into tax harvesting, it’s important to grasp capital gains basics:
- Capital Gains: Profits made from selling investments like mutual funds.
- Short-Term Capital Gains (STCG): Gains from investments in equity mutual funds or stocks sold within a year, taxed at 20% (from 23rd July 2024) and 15% (before 23rd July 2024). For debt mutual funds, STCG is taxed based on your income slab.
- Long-Term Capital Gains (LTCG): For equity mutual funds and stocks held for over a year, gains exceeding Rs 1.25 lakh are taxed at 12.5% (from 23rd July 2024) and 10% (before 23rd July 2024).
Also Read: EPF Pension Scheme: Eligibility, Financial Security, and Tax Benefits explained
Set-off & Carry Forward of Capital Losses:
- Short-term losses can offset both short-term and long-term capital gains.
- Long-term losses can only offset long-term capital gains.
- Certain losses (e.g., speculative) can only offset specific income types.
- Unused capital losses can be carried forward for 8 assessment years to offset future gains.
Understanding Tax Harvesting:
Tax harvesting involves selling portions of your mutual fund holdings to ensure LTCG stays under the Rs 1.25 lakh tax-exempt limit per financial year. By doing this, you avoid paying taxes on your gains while reinvesting the proceeds to maintain your investment, resetting the cost base and preventing taxes from triggering.
The Approach:
Tax harvesting requires regular monitoring of your portfolio’s growth. As your LTCG nears the Rs 1.25 lakh limit, you strategically sell portions of your holdings to remain below the threshold. After selling, you reinvest the proceeds to reset your cost base while keeping your gains tax-free.
Case Study:
Suppose you invest Rs 8 lakh in a mutual fund, and after a year, it grows to Rs 8.85 lakh, yielding a gain of Rs 85,000. Since your gains are below the tax-free threshold, you owe no taxes. Reinvest the Rs 8.85 lakh, and if it grows to Rs 9.6 lakh the following year, yielding a Rs 75,000 gain,
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