Equity tax-loss harvesting is a double-edged sword, make sure it works for you

equity and other investments to set off against capital gains made in the past and, thereby, reducing the tax liability. This strategy is popularly known as «tax-loss harvesting.»

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While one can defer the tax liability with this strategy, it is important to know that it comes with inherent risks. If adequate precautions are not taken while using this strategy, you may end up paying more income tax than before. For example, you may end up paying more taxes if your long-term capital gains are less than Rs. 1,25,000.

Also read | Tax harvesting to rescue equity investors: How loss from equities could help you save more tax

Before we deep-dive into the risk associated with tax-loss harvesting and precautions to be taken, let us understand what tax-loss harvesting is.

What is Tax-loss harvesting and how it is a legal way to save capital gains tax

Assume that you have a short-term capital gain on equity shares of Rs. 4,00,000 during this year, on which you will pay tax @ 20% (assuming the sale is after 22nd July 2024). You have recently started an SIP in an equity mutual fund, and due to the current stock market correction, the SIP is at a loss of Rs 1,00,000.

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You can sell the equity mutual fund, book the short-term loss and set off this loss against short-term capital gain from equity shares, reducing your tax liability. This is tax-loss harvesting — deferring your tax outgo to a later period.

Example of how