How does tax-loss harvesting work?

If your holding period is less than 12 months, you will be subject to the STCG tax. The impact of this tax can be mitigated by booking any short-term losses in other funds to offset the gains by an equal amount. Let's say an investor's short-term gains are Rs 40,000 over the course of a financial year. The STCG tax due is 15% of it, or Rs 6000, under Indian income tax legislation.

However, if this investor also had short-term losses of Rs 20,000 in other funds over the same time period, this loss can be offset against the gains, reducing the tax obligation to Rs 3000. (15 percent of Rs 40,000 gains less Rs 20,000 loss). This taxation law applies to all types of publicly traded mutual funds and stocks.

 For equities funds and shares, LTCG rules apply if the holding period exceeds 12 months, with long-term capital gains exceeding Rs 1 lakh subject to a 10% LTCG tax. As in the last situation, the tax harvesting method can be employed to lower the tax due here as well.

Consider an investor who invested Rs 3 lakh in stocks or an equity fund on January 1, 2020, only to discover that the investment value of their holdings had decreased to Rs 2.70 lakh, resulting in a Rs 30,000 long-term capital loss. Let's pretend this investor didn't book the losses in 2021, but they can still make use of tax-loss harvesting in 2008 against any future gains.

For example, if this person sells a long-term stock fund two years later and makes capital gains of Rs 2 lakh – which is more than the Rs 1 lakh tax threshold – they must pay tax. However, by deducting a loss of Rs 30,000 from the gain for tax purposes in 2020, the effective LTCG will be Rs 1,70,000, compared to Rs 2 lakh in capital gains.