Tax harvesting is a strategic approach to lowering your tax burden by selling investments at a loss to offset capital gains. This tactic is particularly useful for investors who wish to optimize their tax efficiency while managing their portfolios effectively.
How It Works (Example):
Let’s say Person A earns ₹1,000 in short-term capital gains (STCG) this year. Under current tax rules, A must pay 15% of this amount as tax, which is ₹150.
Now, suppose A owns shares with an unrealized loss of ₹600. By selling these shares, A can offset the loss against their gains, reducing the taxable STCG to ₹400. The tax liability is then recalculated as 15% of ₹400, which equals ₹60.
Tax Savings Breakdown:
- Original Tax: 15% of ₹1,000 = ₹150
- New Tax After Harvesting: 15% of ₹400 = ₹60
- Tax Saved: ₹90
By leveraging tax harvesting, Person A effectively reduces their tax liability while also rebalancing their portfolio.
Why Consider Tax Harvesting?
This strategy is particularly valuable for investors looking to minimize taxes without compromising long-term financial goals. It allows for more efficient portfolio management while aligning with tax-saving opportunities.
Always consult a tax advisor or financial expert to implement tax harvesting effectively and in compliance with applicable regulations.
How It Can Help Compounding ?
Tax Savings Reinvested:
When you save money on taxes by selling investments at a loss, you can reinvest those savings. This reinvested money can grow over time and benefit from compounding (earning returns on your returns).
Better Investments:
Tax harvesting often involves replacing poorly performing investments with better ones. If the new investments grow well, your overall returns improve, which can boost compounding in the long run.
How It Can Hurt Compounding ?
Starting Over with Cost:
When you sell an investment, the new one starts with a fresh cost price. If the new investment grows a lot, you may owe more taxes later, reducing some of the future gains from compounding.
Time Out of the Market:
If there’s a delay in reinvesting the money (for example, waiting to avoid certain tax rules), your money isn’t growing during that time, which can slightly slow compounding.