What is Tax Loss Harvesting and How does It Works
A process when stocks are sold so that the tax liability is reduced on capital gains is called Tax Loss Harvesting. Depending on how long the funds are held, they can be defined as short-term or long-term.
Capital losses can be set off by investors against the capital gains in order to reduce the tax that must be paid. This option is provided by the Income Tax Department. Under Tax Loss Harvesting, equity fund units and stocks can be sold to reduce tax liability. However, there is almost no chance that the loss can be recovered.
Tax Loss Harvesting – Example
Given below is an example of how tax loss harvesting works:
Assumptions
- Long-Term Capital Gains: Rs.1.50 lakh
- Short-Term Capital Gains: Rs.90,000
Tax Liability
- Long-Term Capital Gains: Rs.5,000
- Short-Term Capital Gains: Rs.13,500
Total Tax Liability: Rs.18,500
Using Tax Loss Harvesting of Rs.45,000 due to stocks and equity funds being sold, the total tax liability is given below:
- Long-Term Capital Gains: Rs.5,000
- Short-Term Capital Gains: Rs.6,750
Total Tax Liability: Rs.11,750
The total tax amount that must be paid has been reduced by Rs.6,750
ITR Form
In the case of individuals, the below-mentioned ITR forms must be used:
Individuals who earn an income from interest, house rent (one house), and salary must use this form. However, ITR 1 cannot be used for capital gains.
Hindu Undivided Families (non-business) and individuals who earn an income from capital gains, interest, house rent (one house), and salary must use this form.
Hindu Undivided Families (non-business) and individuals who earn an income from business, capital gains, interest, house rent (one house), and salary must use this form.
The criteria to use this form is similar to ITR 3, however, this form can be used to compute business income under Section 44AE and Section 44AD. The form cannot be used for capital gains.
Intraday Trades – Advance Tax
In the case of business income, it is mandatory to pay Advance Tax. The last day and the percentage of Advance Tax that must be paid are mentioned below:
- 15 June: 15%
- 15 September: 45%
- 15 December: 75%
- 15 March: 100%
Business Expenses – Deduction
Under business expenses, the below-mentioned expenses can be used:
- Magazine and book subscriptions costs that will keep you informed.
- Advisory services costs.
- Consultation fees that are paid to individuals who help in trading.
- Rent for space in case it is used for trading.
- Electronic items that are used for trading.
- Phone bill in case you call a broker.
- Internet bill for placing orders.
- Exchange-levied charges.
- Charges that are related to trading.
Important Things to Know about Tax Loss Harvesting
Some of the important things that you should know about tax loss harvesting are mentioned below:
- Tax loss harvesting must be used only for tax saving purposes.
- Ensure that high risks are not taken to reduce the losses.
- The tax liability must be calculated thoroughly.
- Long-Term Capital Losses must be set off against LTCG, and Song-Term Capital Losses must be set off against STCG.
- There is no guarantee that the losses can be recovered.
Tax Loss Harvesting can be used to reduce the tax liability. However, it is important that money is reinvested.
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