Capital Gain Tax Harvesting is a legal strategy used by investors to minimize taxes by selling capital assets to take advantage of tax exemptions.
Here’s a breakdown of how it works:
- Tax Benefits: Investors can save on taxes each financial year through this strategy, depending on the applicable income tax slab and rates. Many investors take advantage of this in March to maximize their benefits..
- Long-Term Capital Gains Exemption: Investors can claim a ₹1 Lakh tax exemption on long-term capital gains. The 2024 budget has now increased this limit to ₹1.25 lakh.
- Capital Gains Tax: In 2018, a 10% capital gains tax was introduced for shares and mutual funds held for over a year, but only on gains exceeding ₹1 Lakh. For example, if Mr. Kumar has ₹5 Lakh in gains, the first ₹1 Lakh is tax-free, and he pays 10% on the remaining ₹4 Lakhs, resulting in a tax of ₹40,000. The 2024 budget has changed the tax rate from 10% to 12.5%.
How to Save Tax through Capital Gain Tax Harvesting
If someone doesn’t have long-term capital gains in a year but has unrealized gains from shares, they can sell shares to realize a gain of ₹1 lakh each year. They can then repurchase the same shares or others the next day or later, based on their strategy, if they still believe in the stock’s potential.
By doing this, the unrealized gain is converted to a realized gain up to a maximum limit, which is exempt from tax for that year.
In our example, instead of Mr. Kumar realizing ₹5 lakh in gains and paying ₹40,000 in tax, he could sell shares each year to realize only ₹1 lakh, resulting in no tax liability over the years.
Budget 2024, has increased the exemption limit from ₹1 Lakh to ₹1.25 Lakh.
Important Considerations for Capital Gain Tax Harvesting
- Timing of Repurchase: Avoid buying back shares on the same day to prevent it being considered a speculative transaction.
- Tax Savings Limit: The maximum tax-saving benefit is ₹10,000 per year, but remember to account for brokerage fees incurred from buying and selling shares.
- Handling Losses: If there are capital losses carried forward or short-term capital gains, these losses must be adjusted before claiming the ₹1 Lakh exemption. Budget 2024, has increased the limit from ₹1 Lakh to ₹1.25 Lakh.
- End of Financial Year: It’s best to implement this strategy towards the end of the financial year (February or March) to better assess expected profits.
- FIFO Basis: Gains are calculated on a First In, First Out (FIFO) basis, meaning the oldest shares are considered sold first.
- Applicable Assets: This strategy is only applicable to the sale of listed equity shares and equity mutual funds.
