Tax-gain harvesting is basically a strategy to reduce long-term capital gains (LTCGs). It involves selling a part of the mutual fund units to book LTCGs and reinvesting the proceeds into the same mutual fund.
A long-term gain made from equity investments that exceed Rs 1 lakh in a financial year is taxable at 10%. A long-term gain is the returns an investor makes by selling the equity investments held for more than 12 months.
For a first-time investor or new in the mutual funds market, the yearly gains are not likely to exceed the Rs 1 lakh limit immediately. However, when an investor lets the profits run over for a long time, it will cross the threshold after a specific period. For instance, if an investor invests Rs 15,000 per month in equity funds, with 12% average annual returns, the capital gains would round up to an estimated amount of Rs 45,975 in two years. These returns would go up to about Rs 1,06189 in three years, which would invite LTCGs tax.
This LTCGs tax could be saved provided Rs 45,975 is redeemed at the end of two years and reinvested again in the mutual fund. This also leads to an addition to the investment portfolio.
An investor can use this method even when they are investing through systematic investment plans (SIPs). An investor can redeem units that have been held for more than 12 months and reinvest.
On the other hand, in tax-loss harvesting, an investor books losses and offsets gains in any other instrument to bring down the tax liability.
Take, for example, an individual who invests Rs 1.5 lakh in a fund. However, due to volatility in the market, the investment value dipped to Rs 1.25 lakh in two years. There is a loss of Rs 25,000 in this case.
Now, if an investor sells this investment, they are booking the losses, but they must remember to reinvest this money immediately. The investor can use this to offset any LTCGs earned from another fund in a particular year.
Tax-loss harvesting thus helps to save tax for investors. Ideally, tax-loss harvesting would prove fruitful if underperforming funds are removed from the portfolio and continue to remain invested in good funds, which might have witnessed a small blip in the short term.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.