If you invest, you know that a portion of your gains goes toward “taxes”. What if we tell you, there is a way to reduce or even eliminate this tax? That’s where Tax Harvesting comes in. Investors use this strategy to retain profits they earn and save taxes. In this article, let’s talk about how tax harvesting works, when to use it, and how you can plan to save taxes effectively.
What Is Tax Harvesting?
‘Tax Harvesting’ is a strategy that helps investors reduce their tax liability. There are two types of tax harvesting methods. One is ‘Tax Gain Harvesting’ and the other is ‘Tax Loss Harvesting’. Let’s understand each method.
What Is Tax Loss Harvesting?
Under tax loss harvesting, investors book losses to set off the realized losses made from one investment with the gains made from a different investment. This helps reduce the net gains and in turn reduces the overall tax liability.
Before we get into how this works, let’s look at the basic tax structure. There are two types of taxes involved:
- Short-term Capital Gain
- Long-term Capital Gain
Short-term capital gains (STCG) are charged on gains realised within 1 year of purchasing the investment. For example, if you purchased a stock on 2 February, 2024 and sold it on 2 December, 2024, the gains realised from this transaction will be taxed as a ‘STCG’.
Long-term capital gains (LTCG) on the other hand are charged on gains realised after 1 year of purchasing the investment. For example, if you purchase a stock on 2, February, 2023 and sell it on 2, March 2025. In this case, since you held the investment for more than 12 months, a LTCG will be levied.
How Does Tax Loss Harvesting Work?
Let’s take an example where you invest in 2 funds one is in loss and the other is making profits. Let’s look at the tax payable in both scenarios.
Say you invested ₹10,00,000 in two funds. After 8 months:
- Fund A had a loss of ₹1,50,000.
- Fund B gained ₹250,000.
| Funds | Initial Investment | Value after 8 months | Gains/Loss |
| Fund A | ₹10,00,000 | ₹8,50,000 | - 1,50,000 |
| Fund B | ₹10,00,000 | ₹12,50,000 | + 2,50,000 |
Without Tax Loss Harvesting:
- STCG (Short-Term Capital Gains) is charged at 20%.
- Total gains: ₹2,50,000
- STCG Tax: ₹2,50,000 x 20% = ₹50,000
With Tax Loss Harvesting:
- You sell Fund A and book a loss of ₹1,50,000.
- You also sell Fund B, realizing a gain of ₹2,50,000.
- Net gain: ₹2,50,000 - ₹1,50,000 = ₹1,00,000
- New STCG Tax: ₹1,00,000 x 20% = ₹20,000
By using the tax loss harvesting method, you saved ₹30,000 in taxes (₹50,000 - ₹20,000).
Tax loss harvesting is a smart way to reduce your tax liability and increase post-tax returns. It allows you to manage capital gains efficiently and make the most of available exemptions.
What Is Tax Gain Harvesting?
What you read above was an example of ‘Tax Loss’ harvesting. Now, let’s look at another method - Tax Gain Harvesting. ‘Tax Gain Harvesting’ is a strategy that involves redeeming your investments and reinvesting the proceeds each year to reduce tax liability on long-term capital gain.
How Does Tax Gain Harvesting Work?
Let’s understand how tax harvesting works with an example. For this explanation, let’s look at the tax structure of an equity investment:
| Tax | Holding Period | Tax Liability |
| STCG | Less than 12 months | 20% |
| LTCG | More than 12 months | Exempt up to ₹1,25,000 then 12.5% |
Say you invested ₹10,00,000 in a mutual fund in February 2022. In February 2025, the value of your investment becomes ₹15,20,875 with a CAGR of 15%.
Let’s see what your tax liability would look like without tax harvesting:
Long-term Capital Gains: ₹15,20,875 - ₹10,00,000 = ₹5,20,875.
Taxable Amount: ₹3,95,875 (5,20,875 - 1,25,000 Exemption).
LTCG Tax: ₹3,95,875 x 12.5% = ₹49,484.
You will have to pay a tax of ₹49,484 on the realized gains from your investments.
Now, consider you follow the tax harvesting method. This would mean that you sell the proceeds of your investments at the end of each year and reinvest the entire amount in the same fund. Let’s look at how your tax liability would look like:
Considering CAGR to be 15%.
| Year | Investment at the beginning of the financial year | Investment value at the end of the financial year | Gains | LTCG |
| 2022 | ₹10,00,000 | ₹11,50,000 | ₹1,50,000 | 3125 (25,000*12.5%) |
| 2023 | ₹11,50,000 | ₹13,22,500 | ₹1,72,500 | 5938 (47,500 *12.5%) |
| 2024 | ₹13,22,500 | 15,20,875 | ₹1,98,375 | 9172 (73375*12.5%) |
| 2025 | 15,20,875 (Reinvested) | – | - | 0 |
| Total Tax | 18,235 |
The above example shows how your tax liability comes to ₹18,235. This was calculated after removing 1,25,000 (exemption limit) on each year's total gains.
On the other hand, if you sold all your proceeds in one go (as in the first example), you would have to pay ₹49,484 in taxes. By following the tax harvesting method, you saved ₹31,249 in taxes.
By using a simple approach of tax harvesting, you saved ₹10,418 in taxes.
Where Can You Use Tax Harvesting?
Tax gain harvesting is a strategy for investors to reduce capital gains on their equity investments. Investors reap maximum benefits of tax harvesting when saving for taxes on long-term capital gains. Under tax loss harvesting, investors can offset their gains from the losses of equities of both Indian and US Stocks.
Save Taxes On Capital Gains: Benefits Of Tax harvesting
The benefits of tax harvesting go beyond saving taxes on capital gains. Here are some other key benefits of this tax-saving strategy:
1. Maximises Post-Tax Returns
With tax harvesting, investors not only save taxes, but also retain more profits with themselves. Especially under tax gain harvesting, when investors reinvest the proceeds, it ensures they continue to benefit from compounding and maximise returns.
2. Strategic Portfolio Rebalancing
Tax loss harvesting is a strategic approach that lets investors relook at their portfolio and rebalance to reap maximum benefits. Selling ‘loss making' investments helps them maintain tax efficiency and realign investments for profitability.
What Are The Risks Involved With Tax Harvesting?
For most parts tax harvesting is considered a prudent strategy to save tax, however, there are some limitations that investors should be aware of. These include:
1. Market Timing
While tax harvesting allows you to sell and reinvest in securities, it also means that you are out of the market for a very short period of time. If the market rallies after you sell, you might have to reinvest at higher prices.
2. Liquidity
When you sell an investment, transaction costs, brokerage, etc., are included. Further, the redeemed proceeds can take up to 2-3 business days to get credited to your account. Investors should ensure they have enough liquidity to reinvest the funds.
How To Plan Tax Harvesting Effectively?
You must plan out your tax harvesting strategy on time to make the best use of it and make informed decisions. To do this, follow the below steps:
Step 1: Know your tax gains
Look at your investments and your tax report to identify your total short-term and long-term capital gains. You can find your tax reports easily with the broker you use to invest in.
Step 2: Identify the right investments
Next, look at your investments. Set aside investments that are making a loss and profit-making investments. If you do not have loss-making investments, consider selling and reinvesting to save tax.
Step 3: Time and sell your investments
Sell your investments before the financial year ends (before 31st March). This ensures your realised loss is attributed to that year itself.
Step 4: Plan reinvestment
Plan and reinvest immediately to continue staying invested in the market and not lose out on potential gains.