Tax loss harvesting is one of the most popular ways deployed by investors and traders in the stock markets to offset losses incurred on sale of equities and lower the amount of capital gains, which helps in lower the tax liability.
You can save taxes on the profits made in the market rally. Yes, you read that right — tax saving is possible on stock market gains. The year 2023 turned out to be a great one for Indian stock market investors compared to previous years. Benchmark indices Sensex and Nifty posted over 20% gains last year as compared to just 4% rise in the previous year. Now, you might be wondering if there are ways you can minimize taxes on these profits and retain as much of earnings as possible.
While taxes cannot be avoided, there are strategies to reduce your tax liability on capital gains, such as tax loss harvesting.
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Short-term and long-term capital gains
First, we will understand capital gains and its two types – short-term capital gains (STCG) and long-term capital gains (LTCG). When you sell equities within 12 months of buying them, the difference in sale value and purchase price is considered as short-term capital gains. Short-term capital gains attract 15% tax under the income tax laws. As regards LTCG, if you sell equities after 12 months of purchasing them and make profit, the differential amount between sale value and buying price is called long-term capital gains. Similarly, if there is a loss and the holding period is less than 12 months, it will be called short-term capital loss; and if the equities are held for longer than 12 months, the amount is computed as long-term capital loss.
Until March 2018, there was no tax on long-term capital gains (LTCG) from the sale of equity or equity-oriented mutual funds. In the budget 2018, the central government announced that LTCG of up to Rs 1 lakh would be free from tax and above that limit would be taxed at a rate of 10%.
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Three effective strategies to save tax on stock market profits:
Tax loss harvesting
When you sell a stock for a profit, it’s ‘realized gains’, so it is subject to taxation. On the other hand, if you incur loss on selling stock, you can use the amount to offset your ‘realized gains’ and this strategy is known as tax-loss harvesting. While a taxpayer can use tax loss harvesting at any time of the year to reduce his or her tax liability on sale of equities or mutual funds, this method is mostly executed in March before the end of the current financial year. However, one can also take advantage of tax loss harvesting when filing their income tax return.
For example, let’s say you have realized Rs 1 lakh in short-term capital gains (STCG). The tax rate on STCG is 15%, resulting in a tax liability of Rs 15,000. However, if you have suffered losses on other investments amounting to Rs 70,000, you can offset these losses against your capital gains. This reduces your net capital gains to Rs 30,000. Applying the 15% tax rate to this amount results in a tax liability of Rs 4,500 on your capital gains.
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Extend investment horizon for long-term capital gains
Another smart way for stock market traders to save tax is extend yourr investment horizon to qualify for long-term capital gains tax rates. If you hold investments for more than one year, they are classified as long-term and enjoy preferential tax treatment compared to short-term investments.
As short-term capital gains on stocks held for less than a year attract 15% tax, holding investments for more than a year can reduce tax rate on capital gains. Currently, long-term capital gains on listed equities and equity-oriented mutual funds are taxed at a rate of 10% for gains exceeding Rs 1 lakh in a given financial year.
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Equity Linked Savings Scheme investment
ELSS (Equity Linked Savings Scheme) mutual funds are a smart way to invest and also save tax. The investment option is designed specifically for those who want to save taxes under Section 80C of the Income Tax Act. ELSS mutual funds primarily invest in equities, offering customers capital appreciation benefit alongside tax saving option. ELSS investors are allowed to claim tax deduction benefit of up to Rs 1.5 lakh in a financial year.
ELSS funds have a lock-in period of 3 years years, which helps in promoting the instrument as a long-term investment tool. ELSS funds’ horizons align with the objectives of many stock market traders. Moreover, ELSS funds also give investors the flexibility to choose the SIP mode of investment, which allows them to invest regularly and benefit from rupee-cost averaging.
