With the sudden and prolonged crash in the stock market that has shaved 37 per cent off Sensex in just 45 sessions, most investors are sitting on huge losses. However, losses can turn into opportunities. Since the market crash has coincided with the year-end tax planning, there are ways to make your losses work in your favour. One such way is tax-loss harvesting.
Tax loss harvesting utilises the losses on sale of equities/mutual funds to offset the capital gains arising out of selling these assets. "If the investor feels that the security has lost significant value and its chances of rebound are bleak, they can sell such stocks or mutual funds experiencing a price decline and offset this loss with capital gains that they have already earned during the financial year," says chartered accountant Amitabh Sethi.
The strategy could come handy to reset your asset allocation as well. "The amount realised from the sale of the loss making stocks/mutual funds can be used to buy alternative lucrative stocks/mutual funds based on the risk appetite and the asset allocation for fulfilling one's financial goals," Sethi says.
In the ongoing market situation, however, even if you feel the stocks/mutual funds in your portfolio hold value, you may consider selling them to book losses and buy again to let the portfolio remain unchanged.
In case of mutual funds, investors can either redeem their units as per the current net asset value and book losses or switch between different schemes of the mutual fund house. You may switch from an equity fund to a debt fund as well. "In case the investor sells the equity fund units and switches to the debt fund, the capital gain or loss will arise on the sale of the equity fund units," says Archit Gupta, Founder and CEO, ClearTax says.
Note that long-term capital gains on selling equities and equity-oriented mutual funds are tax-exempt up to Rs 1 lakh annually. However, long term capital losses can be set-off only against long-term capital gains and short-term capital losses can be set-off against either short-term capital gains or long-term capital gains.
If you are unable to set off losses due to insufficient capital gains or lack of capital gains, the losses can be carried forward up to eight succeeding years, but it cannot be carried forward if you don't file the income tax return within the original due date. Below is an example to understand tax-loss harvesting better:
If you have booked short-term capital gains of Rs 1 lakh and long-term capital gains of Rs 2 lakh in financial year 2019-20, your tax liability will come out to be Rs 25,000 (Rs 1 lakh STCG at 15 per cent and Rs 1 lakh LTCG at 10 per cent excluding tax exempt Rs 1 lakh). If you book short-term and long-term capital losses of Rs 1 lakh each before the end of financial year and set it off against capital gains, your tax liability will come out to be zero.
Note that tax-loss harvesting is a complex process. You must consult a financial advisor before you go ahead with it.