Tax loss harvesting in Mutual Funds

Investing in mutual funds is a popular avenue for achieving a wide range of financial goals. However, like any investment, mutual fund schemes come with their share of risks and uncertainties. The financial markets can be unpredictable, subjecting you to the potential of losses. But, as they say, every coin has two sides. Fortunately, there is a strategy known as tax loss harvesting in mutual funds that can help you navigate the challenges posed by taxation. Let’s dig deeper into this strategy and discover how it can be a valuable tool in your investment journey.

What is tax harvesting in mutual funds?

Tax loss harvesting is a tax strategy that can be used when investing in mutual fund schemes. It involves strategically selling investments that have incurred losses to offset gains in your portfolio. This technique not only helps minimise the impact of losses on your overall returns but also provides an opportunity to reduce your tax liability.

How does tax loss harvesting work with mutual funds?

Consider an example where you have an investment portfolio with Long-Term Capital Gains (LTCGs) from equity funds. At the end of the financial year, your portfolio performed as follows:

LTCGs = Rs 3,50,000

However, only LTCGs exceeding Rs 1,00,000 are taxable. Hence, your tax liability is as follows:

Taxable LTCG = (Rs. 3,50,000 – Rs. 1,00,000) = Rs. 2,50,000

Here’s how you can calculate the tax on the taxable LTCG at a rate of 10%:

Rs 250,000 x 10% = Rs 25,000

Now assume you have a Long-term capital loss of Rs 50,000 in your portfolio due to another mutual fund scheme. To offset gains with losses, you need to subtract the capital loss from the initial taxable gains, as shown below:

New LTCG = Rs 250,000 - Rs 50,000 = Rs. 200,000

You can now calculate the tax on the adjusted taxable LTCG at a rate of 10%:

200,000 x 10% = Rs 20,000

Your new tax liability is Rs 20,000, significantly lower than the initial Rs 25,000. By employing tax loss harvesting in mutual funds in this adjusted scenario, you have effectively reduced your LTCG tax liability from Rs 25,000 to Rs 20,000, resulting in tax savings of Rs 5,000.

When it comes to tax loss harvesting for mutual funds, there are some important rules and considerations that you should keep in mind. These rules revolve around the nature of capital losses and gains, as well as the prevailing tax laws for equity and debt mutual funds.

Tax loss harvesting rules for mutual funds

• You need to have capital losses to avail of tax loss harvesting on your profits. If you have no losses, you cannot use this strategy to lower the value of your taxable profits.
• Long-term capital losses in mutual fund schemes can be set off only against long-term capital gains. In other words, if you have a capital loss from a mutual fund investment held for more than one year, you can offset it against long-term capital gains from other investments. This rule is specific to the duration of the investment.
• Short-term capital losses offer more flexibility. You can set off short-term capital losses against both short-term and long-term capital gains. This means that losses from mutual funds held for less than a year can be used to offset gains from investments of any duration.
• Tax loss harvesting in mutual fundsis subject to the prevailing tax laws, which can change over time. It is crucial to stay informed about the current tax regulations for debt and equity mutual funds to make informed decisions.
• If you still have a net capital loss after offsetting your current-year capital gains with capital losses, this loss can be carried forward to future tax years. You have a window of up to eight years to utilise the carried-forward loss to offset any capital gains you may incur during this period.

Conclusion

While tax loss harvesting in mutual funds can be a good strategy for optimising your investments, it is essential to understand and adhere to the latest tax rules governing the offsetting of capital losses and gains. It is advisable to consult with a tax professional in case of a doubt.

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