By offsetting gains with losses, investors can use a strategy known as tax harvesting to lower their tax responsibilities. When it comes to investing in mutual funds in 2024, this approach might be very beneficial.
Investors who realize capital losses on underperforming mutual funds can use those losses to offset the taxes they owe on capital gains from their profitable mutual funds. This is how tax harvesting helps investors keep more of the money they make from their investments while potentially reducing their total tax liability.
We will discuss tax harvesting in this blog post, along with how it applies to mutual fund portfolios.
Recognizing Tax Harvesting in Mutual Funds
Mutual fund tax harvesting is the practice of selling mutual funds at a loss in order to deduct capital gains from other assets and reduce the overall tax bill. This strategy takes advantage of certain tax laws that permit the adjustment of losses against earnings. It is also an option for investors to book profits of up to Rs. 1 lakh and subsequently buy back the same or similar investments. As gains up to Rs. 1 lakh are tax-free, this method effectively makes earnings tax-free, much to the concept of wash sales.
Common Mutual Fund Tax Harvesting Strategies
Liquidating underperforming mutual funds
One such easy way to have taxes paid is to sell mutual funds that have underperformed. By realizing these losses, investors can reduce their taxable income by offsetting gains from other investments. During the latter months of the fiscal year, this process is commonly employed to reduce losses for tax purposes.
Switching Across Different Mutual Fund Plans
Altering between mutual fund schemes provided by the same fund provider represents an additional tactic. By moving from one scheme to another, investors can reduce their taxable income while keeping their investment and offset long-term losses from one scheme to another.
Using Wash Sales
A “wash sale” is the process of selling a mutual fund at a loss and then quickly repurchasing it. In addition to allowing investors to record losses for tax purposes, this maintains their investment position. This strategy works, but you have to use caution when using it to avoid being inspected by unapproved tax authorities.
Tax Laws in India Regulating Harvesting
To implement tax harvesting legally, it is essential to understand the relevant income tax rules in India:
Part 112A
Section 112A (LTCG) deals with Long-Term Capital Gains. If the proceeds from the sale of equity-oriented mutual funds, listed equity shares, or business trust units exceed Rs. 1 lakh, 10% tax is levied without indexation benefits. This tax may only be imposed in specific circumstances if the Securities Transaction Tax (STT) was paid at the time of both the acquisition and the transfer. This only matters if the stock shares or funds are sold after being owned for more than a year.
Part 111A
See Section 111A for information on Short-Term Capital Gains (STCG). Gains from selling stock shares and equity-related instruments that you have held for a year or less are covered in this section. Should the Securities Transaction Tax (STT) have been paid at the time of transfer, these gains would be taxed at a flat rate of 15%. Failure to pay STT results in gains being taxed at the individual’s income tax slab rate.
Debt funds are not covered by this section any more. Debt funds, regardless of duration of holding, are now subject to taxation at the individual’s income tax bracket rates. Gains from debt funds will now be taxed based on the investor’s total income rather than short-term holdings having a separate, potentially lower tax rate.
Section 70: Decreased Values
The Income Tax Act of 1961’s Section 70 allows losses from one source to be deducted from income from another source under the same subject of taxation. This is crucial for strategies related to tax planning and the collection of tax losses. Key information includes:
Both long-term and short-term capital gains can be used to offset short-term capital losses.
Deductions for long-term capital losses are only allowed for long-term capital gains.
Certain losses can only be subtracted from specific types of revenue, such as losses incurred through speculation.
Parts 73–74: Guidelines for Carrying Over Losses
Under Sections 73–74, capital losses may be carried forward to offset future capital gains for a maximum of eight assessment years. This extends the tax benefit period by allowing investors to deduct these losses from future gains.
Practical Application of Tax Harvesting
Investors should employ tax harvesting wisely to avoid fines. The following are some helpful hints:
- Examine your portfolio first. Frequently: Check your mutual fund investments frequently to identify underperforming funds that might be sold for tax harvesting.
- Make a plan in advance: Use tax harvesting strategies when the fiscal year is coming to an end to optimize the benefits.
- Be Aware of the Guidelines: Learn the relevant tax regulations so that you can avoid any potential risks and guarantee compliance.
- Seek Guidance from a Financial Consultant: Expert advice may make it easier to tailor tax harvesting strategies to your particular financial situation and goals.
In conclusion
Tax harvesting is a practical method for reducing tax liabilities in a mutual fund portfolio. By effectively managing their investments and applying and comprehending the relevant tax legislation, investors can maximize their tax consequences. Tax harvesting must be done lawfully and morally, just like any other financial plan, in order to reap the full rewards and stay out of trouble.
