Tax-Efficient Investor: A Deep Dive into Profit and Loss Harvesting

Venturing into the world of stock market investment presents both lucrative opportunities and complex challenges. Among the strategies available to savvy investors, tax harvesting stands out as a powerful tool for optimizing returns and managing tax liabilities. In this article, we will explore the concept of tax harvesting with the help of practical examples.

Basic Tax Concepts 

Before understanding the tax harvesting process, let’s understand some basic concepts:

1. Short-term Capital Gains (STCG) on sale of listed equity shares held for less than 12 months is taxed at 15%.

2. Long-term Capital Gains (LTCG) on sale of listed equity shares held for more than 12 months and exceeding Rs. 1 lakh is subject to a 10% tax rate without indexation benefit.

Loss Harvesting – Turning Losses into Tax Advantages

Now, let’s begin with the concept of loss harvesting. Consider two investors, Shreyans and Akash, who each bought 100 shares of two different companies – ABC Co. for the short term & XYZ Co. for the long term. In 6 months, ABC shares are currently in profit, while XYZ shares are currently in loss.

Shreyans decides to sell ABC for a profit of Rs. 50,000 and hold onto his losing investment XYZ, hoping it will turn profitable in the future. However, he is now subject to a short-term capital gains tax of 15 percent on his ABC gains.

In contrast, Akash, while realizing the Rs. 50,000 short-term capital gains from ABC, takes a different approach. He decides to book the loss on his XYZ investment by selling his 100 shares at a loss of 30,000 rupees and repurchasing the same 100 shares after a mere two days. This strategic move allows him to offset his short-term capital gains, which would otherwise be taxed at 15 percent. In essence, he leverages the short-term loss to reduce his taxable income. While this may seem counterintuitive in the short term, as he’s realizing a loss, he is, in fact, proactively managing his tax liability.

While the initial loss he recorded lowers his cost basis, his continued long-term position allows him to leverage the Rs. 1,00,000 exemption, which will be taxed at 10%.

Profit Harvesting – Maximizing Gains While Minimizing Tax Exposure

Let’s explore profit harvesting. Imagine Vishal decides to invest in shares of LMN worth 10 lakh rupees with a target of achieving a 20 percent gain in two years. After two years, Vishal’s investment is now worth 12 lakhs, and he’s pleased with his gains. However, he’s also aware that he’ll owe long-term capital gains tax on his profit.

This is where profit harvesting comes into play. Vishal can opt to sell shares worth 11 lakhs after just one year and repurchase them within two days. This clever manoeuvre enables him to lock in a tax-exempt 1 lakh profit while retaining his stake in LMN shares. Consequently, his new cost basis becomes 11 lakhs.

Now, after another year, if Vishal’s investment appreciates to 12 lakhs, he has two choices: either cash out his profit, resulting in zero taxes (thanks to the adjusted cost basis of Rs. 11,00,000 and the Rs. 1,00,000 long-term capital gains exemption), or repeat the sell-and-buy-back process if he intends to hold onto his shares. By adopting this strategy, Vishal effectively “harvests” his profits, capitalizing on the annual 1 lakh exemption for long-term capital gains. As a result, his tax liability remains minimal, enabling him to reach his investment objectives without incurring significant tax expenses.

The key takeaway from profit harvesting is that individuals like Vishal can strategically manage their gains to avoid excessive taxes while still attaining their investment goals.

However, tax laws may change, so it’s essential to consult a tax professional or financial advisor for personalized advice based on your specific circumstances and the latest tax regulations.

Also, some charges in the form of brokerage, STT etc. will be incurred in the process. Also, since the shares are being bought back after two days (to avoid the transaction becoming an intraday trade), one must make such adjustments when the share is consolidating and a sideways price trend is expected.

Conclusion

Profit and loss harvesting are powerful strategies that can help investors achieve their financial goals while minimizing their tax burdens. By understanding these concepts and applying them wisely, you can optimize your investments and keep more of your hard-earned money.

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Author: Nikhil M. Bijutkar | Associate Consultant | Email: nikhil.bijutkar@masd.co.in