What is Tax Loss Harvesting
21 August, 2023
Prudent investment is a powerful tool that empowers you to achieve various life goals. You must choose investments that align with your objectives, risk tolerance, and time horizon.
A comprehensive investment strategy is founded on diversification, a long-term focus, risk management, knowledge and education, and consistency. One important factor that aids in increasing your possibilities of earning returns is tax loss harvesting.
What is tax loss harvesting?
Imagine that you have invested in stocks or other assets. But instead of earning profits, the asset's value goes down. This loss is known as a capital loss. The silver lining, in this case, is that it can be used to decrease your tax liability through tax loss harvesting.
This technique involves selling loss-making assets to realise the capital loss and using it to offset the gains earned by profit-making assets.
Tax loss harvesting is the technique of taking advantage of capital losses to offset capital gains.
How does tax loss harvesting work?
Identify your underperforming assets, especially during the market downturn: First, determine the investments in your portfolio that have lost value. These investments could include stocks, bonds, mutual funds, or other types.
Sell it to result in a capital loss for you: Sell the loss-making investments to realise the loss, which entails offering them for less than what you bought them for.
Pay lower taxes and save a significant amount: You can utilise the capital loss you have incurred to lower or even eliminate the taxes you would have otherwise owed if you sold any asset at a higher value. You can carry over your capital losses for up to 8 assessment years if it outweighs your profits.
Reinvest the money saved in an asset that fits your investment strategy: The money you save can be reinvested in lucrative assets to improve the position of your portfolio.
Tax Loss Harvesting Benefits
How can investors take advantage of the tax loss harvesting strategy?
Tax loss harvesting is most suitable for investors with taxable investment accounts who aim to lower their tax liabilities. Several scenarios where this tactic can prove very useful are listed below:
Investors with capital gains: It can be used to balance off gains from other assets in their portfolio that have resulted in capital gains and lower their tax obligations.
Investors with high tax brackets: Lower tax liability is essential if you come in the higher tax brackets. This strategy can lower tax rates and reduce taxable income.
Long-term investors: Tax loss harvesting is particularly beneficial for long-term investors, i.e. if you have held your investments for longer than a year. The reason is that long-term capital gains are taxed at a lower rate than short-term ones.
Diversified portfolios: When you have a diverse portfolio with several investments that have suffered losses, tax loss harvesting is the most efficient. You can use losses in one investment to offset gains in another.
Investors without selling limitations: Since tax loss harvesting necessitates selling investments that have suffered losses, it may not be appropriate for investors with selling restrictions.
Essential things to keep in mind
When considering tax loss harvesting, you should be mindful of some key points:
Long-term plan: Tax loss harvesting is long-term, not a quick fix for lowering taxes.
Investment objectives: Tax loss harvesting shouldn't interfere with your overall investment objectives or plan.
Brokerage fees: Think of this additional cost while engaging in tax loss harvesting to justify the effort.
Tax implications: Evaluate well before using the tax loss harvesting strategy to lower taxes in the short term. It may have long-term tax repercussions.
Contact a professional: To be sure that tax loss harvesting aligns with your overall financial goals and plan, think about speaking with a financial professional or tax advisor.
In essence, tax loss harvesting can help investors reduce their tax liabilities. Those with taxable investment accounts and long-term investments stand to gain the most from it. Nonetheless, you should consider all potential consequences and do a thorough cost-benefit analysis.
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*Terms and conditions apply. This is an information communication from HDFC Bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.
