How Can Investors Benefit From Tax-Loss Harvesting?

How Can Investors Benefit From Tax-Loss Harvesting?

The tax-filing season just went by. We hope you filed your taxes on time, although giving your hard-earned money to the government might not have felt good. So here’s a strategy to defer your tax outgo – tax-loss harvesting!

What is Tax-Loss Harvesting?

Tax-loss harvesting is a strategy where an investor deliberately sells an investment for a loss so that it can be offset against investments which were booked at a profit. This will reduce the taxes on gains paid by the individual for the given financial year.

The gist is that you are liable to pay taxes only on the net gains made on investment securities by engaging in the tax-loss harvesting strategy. It is also important to note that you cannot offset investment losses against personal income.

Tax-Loss Harvesting Does Not Reduce Your Tax Outgo!

It is of immense importance for investors to understand that the tax-loss harvesting strategy does not reduce your tax outgo; it only defers your tax outgo. To understand this, let’s take a simple example.

Consider you are in March, and to reduce your tax outgo, you decide to book a loss on a security ‘ABC’ which you purchased at Rs 50, now quoting at Rs 35. So you decide to sell the security and book a loss of Rs 15.

You now use this Rs 15 loss to offset it against your profit. And you again buy the security ‘ABC’ at Rs 35 because your only purpose was tax-loss harvesting. What now happens is that your cost basis for tax calculations on security ‘ABC’ has now become Rs 35 instead of the previous Rs 50. This will lead to an increased tax burden if gains are made on security ‘ABC’.

How is Tax-Loss Harvesting Beneficial for an Average Investor?

The critical question is that if we defer current year taxes at the expense of a higher future tax burden, what’s the advantage of this strategy?

The answer is that deferring taxes today and paying them sometime in the future is beneficial as it helps in tax-free compounding of your investments. In essence, it is the time value of money at play here!

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