An introduction to Tax Loss Harvesting
Tax Loss harvesting is the practice of selling a share that trades below your buy price, so that you can convert the book losses you see into real losses.
When we trade and invest in Equities (and/or Mutual funds) a market which has many ups and downs is very useful. If you have an Equity portfolio and wish to build it over a period of say 30-40 years, you will end up buying shares on a regular basis.
Let us say you have Short term capital gains (from your trading portfolio) of Rs 300,000 and you can see a "book loss" of Rs 80,000 in your investing portfolio. This gives you an opportunity of 'booking' the loss of Rs 80,000 and setting it off against your capital gain - thus saving you about Rs 12,000 of capital gains. This is called TAX LOSS HARVESTING.
Tax Loss harvesting is the practice of selling a share that trades below your buy price, so that you can convert the book losses you see into real losses. The advantage is that if you convert Rs 80,000 book loss to an actual loss, you can perhaps convert a part of the Short term capital gain to a Long term capital gain.
This used to be very attractive when STCG was 20 per cent and LTCG was 0 per cent. Thus a huge arbitrage was possible. However, today the arbitrage is down to 5 per cent - the difference between STCG and LTCG is just 5 per cent. Do remember that there are many other things to consider too - brokerage, price variation risk, administrative headache, etc - so do think twice before you do such arbitrage.
Once you decide to do it, do take a look at your trading or investing account and see what is the situation - is it worth doing this exercise. Also, let us say you had bought the share at Rs 100, and is now quoting at Rs 60.
You get a loss of say Rs 40 per share - and say 2000 shares, so you now have a “booked” loss of Rs 80,000. You need to buy the share at Rs 60 - thus, you will incur the brokerage as the cost of doing this transaction. Technically, you should be buying on the next day - or you risk that the transaction will be treated as a ‘speculative’ transaction and the off-set will not be allowed.
Even better is to sell the shares in your portfolio and buy it in the portfolio of your spouse, children or Huf. This makes it even better - however it is not exactly a tax-loss harvesting the way we see it. It helps you to re-think on your portfolio - and feels less bad about selling a loss making position. I have seen some good shares in my portfolio (which I wish to hold for a long time) quoting at a discount.
However, do remember when you do this Tax Loss Harvesting you are changing the 'cost-basis'. So the above-mentioned share goes back to Rs 200, and I wish to sell it, my new revised cost is Rs 60 - and if I will pay tax on Rs 140. Of course, the more observant reader must have realised that ‘Tax Loss harvesting’ is just a postponement of tax.
An important caveat: When you trade in equity shares you should concentrate on the trade - not so much on the tax. For example if you are seeing that you are sitting on profits - and have a sell call - just sell it - waiting could be expensive.
Do your own due diligence before you try this!
(The writer can be reached at www.subramoney.com and has authored the best seller 'Retire Rich - Invest Rs 40 a day')