Should I book profits each year to lower Equity LTCG Tax?

Readers may recall that I have been covering equity LTCG tax in a series of posts. First, the implications, followed by simple examples on how to calculate LTCG tax after accounting for the grandfather rule. Then we discussed an illustration of how much Equity LTCG tax we need to pay.  Now, in the second part of the illustration let us consider a question on many minds: should I book profits each year (up to the tax-free limit of one lakh) to lower Equity LTCG tax?

Why are investors considering booking profits each year? How does it lower Equity LTCG tax?

Let me give an example to make this clear. Please note if you to save tax or get returns, you need to focus and learn certain aspects of equity investing and taxation (in this case).

Let us start with this simple example:

Suppose you invest Rs. 10,000 in a mutual fund or stock at a NAV of Rs. 1/unit (assume this investment is made on or after February 1st, 2018 so no Jan 31st confusion).

So you get 10,000 units. After one year, the NAV = 2 per unit. So your portfolio value = 20,000.

The capital gain(CG)  = no of units (current price – buying price) = 10000 x (2-1) = 10,000

Now, you decide to redeem 5000 units at a price of 2 and immediately buy it back (not practical, but hey anything works in Excel!).

Units are redeemed on a first-in and first-out basis. As of now, all the 10,000 units were purchased at the same time, so no problem.

You redeem 5000 x 2 = 10,000 and buy it back. We will call this profit-booking or resetting.

After one year the Nav = 3 per unit. (real life volatility will make a big difference to booking profits).

Suppose you had NOT booked profits (no reset),

Then

CG = 10,000 X ( 3-1) = 20,000

Because you did a reset,

CG(reset) = 5000 x (3-1) + 5000 x(3-2).  Do not move forward until you understand this!!

5000 units which were redeemed at NaV = 2 and reinvested at NAV =2 will have a CG = 5000 x (3-2).

Wheres the untouched units have a CG = 5000 x (3-1).

CG(reset) = 10,000+5000 = 15,000.

Now the NAV = 3. Total units = 10,000.

Your CG(reset) is 15,000. You redeem this at NAV =3 and reinvest at NAV =3 (2nd reset).

After one more year, the NAV = 4

CG(no reset) = 10000 x (4-1) = 30,000

CG(with reset) = 5000 x(4-3) + 5000 x (4-2). Why? Again do not move forward until you understand!

Redemption is on first-in, first-out basis. When you did the second rest, you pulled out the oldest 5000 units (purchased at Nav =1 per unit) and repurchased at Nav =3.

So for these units the CG(reset) = 5000 x (4-3).  Now there are an additional 5000 units purchased at NAV =2 during the first reset. For this the CG(reset) = 5000 x (4-2)

So in total, CG(with reset) = 5000 x(4-3) + 5000 x (4-2). = 5000 + 10000 = 15,000

With first reset, the effective CG was lower by 5000. After the second reset, it is now lower by 15000. Again, don’t get too excited. Patience is a virtuosity.

This is the summary of what we have discussed above. Again, take your time and take it in.

Equity LTCG taxation illustration

The 3750 units in year 3 are only for year 4 CG calculation, so don’t worry about it.

If you are ready for the big picture, let us get to it.

Please note, I have only considered a single lump sum investment made on or after February 1st 2018. So no grandfathering business.

Equity LTCG Tax: Illustration 1 (no volatility)

After 13 years of this resetting gymnastics, we have saved a grand sum of  Rs. 3,120. Yay! we are so smart! This benefit is the same as refusing to surrender a policy and making it paid up and getting the accrued bonus which will stay dormant after many years.

Okay, so the NAV growth assumed above was nice and straight. Let us add some volatility and see what happens.

Equity LTCG Tax: Illustration 2 (10K investment + volatility)

Let us try this price sequence.

So now, we have a saving of 11,463 after 13 years. Many new investors with small portfolios and not aware of market swings are likely to call this “a big amount”. Well, some things have to be experienced and cannot be explained in words. If you think this is a great saving, then I wish that you soon become a crorepati lose or gains lakhs in the market on a daily basis. Then you will recognise this “saving” is peanuts. It is a rite to a passage that must be experienced. So do not listen to me.

Now let us increase the investment 10K –> 1 Lakh —> 5 Lakh —> 10 Lakh —> 25 Lakh for the same volatility sequence.

Equity LTCG Tax: Illustration 2a (1 Lakh investment)

Notice how much the tax difference has reduced! Keep an eye on that below. As your portfolio grows, it is a waste of time in trying to figure out how much you redeem because the reward per year will be comparable or smaller to daily market gains or losses!

Equity LTCG Tax: Illustration 2b (5 Lakh investment)

Equity LTCG Tax: Illustration 2c (10 Lakh investment)

Equity LTCG Tax: Illustration 2d (25 Lakh investment)

Like I said, notice the tax rate difference as the money at stake increases! Let us get rich soon people!

Equity LTCG Tax: Illustration 3(1Lakh investment)

Now let us try this price sequence (these are real Sensex annual movements) with a one lakh investment.

Notice the losses. No resetting was done when there were losses.

Equity LTCG Tax: Illustration 3a(1Lakh investment)

Another sequence.

Moral: When the market is rocky and annual (FY) losses are large, you do not reset often (the irony!) the gain from resetting is significant.

The situation is the same with timing the market: volatility will always be reduced but higher returns depend on the price sequence.

In this resetting will always reduce capital gains, but when the market zooms up, the effort does not provide a commensurate reward. If the market is rocky then yes, it has its rewards.

Before you assume resetting is “good”, ask yourself, “over the long term” and all that sort of nonsense, do you expect (read want) the market to move up or move up and down!!

Please do not extrapolate this simple study to your portfolio. You will have many instruments and invest multiple times a year. And if you have been investing for a few years now, the 31st Jan grandfather rule will reduce your losses significantly even if you did not reset.  As your portfolio grows in size, the resetting benefit will not amount to much.

It is clear that many investors will reset, but let us at least acknowledge that it is “behavioural” and not “logical”

For the same rocky sequence, consider a 10 lakh investment.

Equity LTCG Tax: Illustration 3b(10Lakh investment)

Notice the drop in the benefits of resetting as you get richer.

Now, you might say, “I am not rich, so I am going to reset”. Then, my friend, I say to you, “You may not be rich today, Good luck”.

I now eagerly await your brickbats.

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42 thoughts on “Should I book profits each year to lower Equity LTCG Tax?

  1. Thanks a lot, Pattu sir!

    It’s these sort of posts which really give me value by patiently walking through the consequences of a particular action (in this case, an LTCG reset) in different scenarios.

    The LTCG reset was mentioned on other sites (e.g., VRO), but not explained in detail like in your post.

    Given the mental gymnastics involved, especially when you have more than 1 fund, I would think this would be an exercise really not worth the time spent on it.

  2. what will be the impact of LTCG on overall returns without resetting for ivestmetnts over a period of 10y or 15Y? is it safe to aasume atleast 2% less than expected( say i am expecting 12%,now it will be 10 after LTCG)

  3. Question is can anyone become rich with such frequent resetting.. will it not be detrimental to the long term goal of retiring rich

  4. In all your simulations, there is one common theme, you SAVE money by redeeming your investments upto 1 lakh capital gains every year. That is the bottomline! The percentage of savings vary from 1.5% to 8% which is a wide range. Even 1% extra gains is worth it in the long run.

    Every rupee saved is a rupee earned. If you think savings to the tune of 10k to 80k is not worth your time, then perhaps you are uber rich but I will take every penny I can get even if I am rich. If I can save 50k, that’s enough to pay 2 months worth of expenses. Why pay any extra in taxes when you don’t have to? The risk of volatility can be reduced to zero by investing your surplus money from savings account on the same day you put in your redemption request. This means you buy units at the same rate you redeemed.

    There is no need to go over such complex mathematical gymnastics. The math is actually simple for those who have been investing for some time and already have over 1 lakh per year capital gains. By redeeming every year to the tune of 1 lakh CG every year, they are saving Rs.10k in taxes every year. This amounts to 2 lakh saved after 20 years. Again, it might seem like a paltry amount to you but to me every rupee saved is worth it.

    Honestly speaking, this is a one time exercise in an entire year. With online facilities, it’s just 5 minutes of work. Why wouldn’t anyone take the effort to save whatever amount they can just by spending 5 mins a year? Not sure why you’re trying to discourage people to do so.

  5. Being a newbie in mf investment,just advice me whether a avadate investor with little knowledge if tweaking capital gains by resetting each year but want to invest regularly by SIP and stay invested really long ,Should go for booking profit each year and reinvest again? Plain answer will be most welcome. Thanks.

    1. “Plain answer will be most welcome”. You mean plain answer without any support evidence? There are plenty of “experts” who make statements in the media. Please follow them.

  6. Hi,

    Great calculations. You just captured what I was thinking in my mind. After the news came, within 10 mins I was like I should now think about learning how to profit book and reinvest. But the summary of your article says that it is not worth the effort. Clarify this if I am not wrong.

    Also, I wanted to know if loss booking and reinvesting is a good way to cancel out capital gains in a year?

    1. Yes it is not worth it. You can book losses to offset gain, but those losses should after Jan 31st 2018.

  7. Superbly analysed as usual Dear Pattu. Lesson is always same, to keep things simple. But alas, we humans refuse to keep anything simple because we want excitement and noice around us to survive!! In case of debt instruments, we care two two hoots even when paying tax as per slab in case of short term or LTCG of 20% with indexing but are crying and shouting about LTCG on equity. Short term gains in debt funds should also get same treatment as equity short term.

  8. The reason most people are exiting markets is not because the tax implication would be huge if they don’t exit now but because the future uncertainity and the impact that FII and DII faces. Every insurance policy not just ULIP, provident fund, NPS all will be affected with this LTCG. You may not pay taxes but the fund houses pay it. What about mutual fund houses that have to pay taxes as 1 lakh limit is too small per year and most fund houses have multiple funds so 1 lakh limit is too less that they will end up paying taxes more now that can reduce returns and then again double tax if the investor makes more than 1 lakh profits in a year? This may be the reason why market fell on a single day just after the LTCG introduction. Your article is not directly related to this but I get a feeling that most online articles are rubbishing LTCG as a non-event. If it is really a non-event, I doubt there would be such concern raised all over. In other words, it is the “fear” that making the participants exit from markets not that they can save money just by selling and buying stocks/mutual funds later. Remember the liquidity crunch that fund houses faced in 2008-09 during US recession?

  9. Thanks Pattu. As usual, spot on and something that folks who have been investing for last 10 to 15 years can clearly co-relate to.
    10% tax (any which way) is the bottom line, and something that we have to come in terms with.

    That said, the issue is of the paper-work (read cumbersome tracking, reporting, calculating) and paying taxes.
    Life had been ‘relatively’ simple for the smaller DIY longer term equity investor category (but imagine the MF switch scenarios and such) and attendant hassles! It is in light of those, that simpler options like increasing STT or such would have been more palatable.

    Thanks

    1. Thank you. Even if tax free, the investor would have had to track and report it in ITR as exempt income. So the effort is the same.

  10. will it help to
    a) shift from Dividend payout to growth in MF before 31mar18 – especially if the dividends are not required – if in future cash is required then units may be sold ?
    b) Switch required MF before 31mar18, if the same was planed for next year – all are in LTCG mode ??

    thnx

  11. Please read one more time. I didn’t imply that an AMC pay taxes “on your behalf of”. What I mean is – LTCG is applicable for every one, no exemption given to mutual funds or are you saying it is not applicable to them even when they make profits more than 1 lakh in a year while churning portfolio?

    1. They pay no taxes on any transactions made on our behalf. Churning portfolio has nothing to do with tax, expenses maybe.

  12. If you have 1 lakh CG not booking is equivalent to not claiming some insurance premium under section 80 even when you are not exhausting 1.5L limit. Nothing wrong with it and if your salary is high the saving is insignificant. I can understand the argument of both sides. But if you want your finance to be optimal booking is the option.

    Now will you get same entry point as your exit that is a different issue. May be on an average over few years you get the same entry point.

    May be govt will fix the issue by introducing some wash sale kind of rule present in other countries for booking losses and then it will be simple for the investor to take a decision (that is you cant book the profit anyway)

  13. I am wondering what would do with auto pilot mode investing? Thats also with 5 L yearly with monthly SIP mode.
    Should i redeem all and start fresh investing?

    Bdw you have nailed the problem in detailed. I have to give 10% from my Retirement fund corpus to govt, where Govt has not done anything good for my career or family support.:)

  14. Sir,
    A simple question.
    In your example of 10000 units of 1 Rs each, why would you not sell all 10000 units in 1st year, 2nd year, etc and buy back which will result in Zero capital gains for many years? I mean this will reduce the number of units (significantly lesser than non-reset) you will have in your portfolio in the 15th year which will result in lesser CG.
    I mean we need to utilize limits till Rs.1 Lac every year by selling enough units and booking gains.
    I wonder if the rest of the calculation takes care of this.

    Another thing about this calculation is that, you keep 1 Lac exemption limit constant for 15 years. Thats not a good assumption to make. We can reset gains starting now and hope that this limit gets revised upwards every few years
    (Hope of getting higher return is what driving us to equity investment anyway) .

  15. Nothing better than “seeing” data. I need to read a few times before I can honestly say that I have internalized this series of post. Thank you.

    Just a small comment – ~ 80000 tax (case 2d) after 13 years is not a big sum to pay considering the hassles of redeeming every year and ensuring that I do not cross the Rs 10000 tax break. For 13 years the CA fees will likely be more. On the other hand if I think from a rebalancing point of view, then it is inevitable, and a nightmare, unless a tax software or a freefincal helps ! I hope you will at some point of time comment on what this tax might do to influence the tendency to invest in more funds than necessary, or the value of debt funds (with indexation benefits) compared to equity funds. Thanks again.

  16. My understanding is that profit booking or reset simply means sell to accrue CG for this FY and then buyback for so as to increase the base price against which CG will be calculated in next FY. So as NAV appreciates, you are basically just increasing the cost price every year and profit is booked because new cost has accrued profit.

    Regarding snippet of your article:

    “Now, you decide to redeem 5000 units at a price of 2 and immediately buy it back (not practical, but hey anything works in Excel!).

    Units are redeemed on a first-in and first-out basis. As of now, all the 10,000 units were purchased at the same time, so no problem.

    You redeem 5000 x 2 = 10,000 and buy it back. We will call this profit-booking or resetting.”

    1. So if I sell 5000 at NAV of 2 which were purchased at NAV of 1, the CG should be 5000x(2-1)= 5000. But you instead use redeem value as CG after 1st reset. Why ?
    2. Also, why do you not reset all the units every year instead of redeeming fraction of units in portfolio ?

  17. Good way of looking at the stats-
    some critical observations —
    1. Not considered compounding effect of tax saved and reinvested. (typically if you save 10000 every year and reinvest into some fund giving you 15% CAGR, your savings in 20 years will be more than 11 lacs and not just 2 lacs as per your calculations)
    2. Please also consider possibility of a bad year where the possibility of showing capital losses are huge. It may save a lot of tax

    If you can help share your calculations considering both above, surely it will give a different perspective to even RICH with portfolios in excess of 50 lacs.

    Manish

    1. Where is the tax saving? the 1L represents a tax free limit. There is no saving if you reset up to 1L (or more)!
      I have considered a case where only gains are reset. I have no desire to include losses.

  18. I dont understand ‘Number of Units Reset column in the calculation above.
    If I invest 5,00,000 at 118 and get 4200 units and after a year the NAV is 148 (CG 4200 * 30 =126000) . So I would realise 100,000 of the gains by selling and buying back about 3300 units. So effectively my CG carried forward into next year is just 25,000 for 900 unsold units.

    Then next year if the NAV goes upto 228, Now i sell 900 unsold units for CG 110/unit = 99,000 realised gain. My gain carried fwd to next year is only 3300 * 80 = 2,64,000.
    If I get a bad year next NAV drops to 178 then my CG of 2,64,000 gets reduced to 1,32,000 which I can redeem and reduce CG to 32,000 carried forward to next year. And I also have CL of 36,000 (from the other 900 units) which leaves me with 4000 as CL

    So after 3 years of resetting I have a CL of 4000 but i have realised gains of 3,00,000 so far.
    If no reset was done then my gains would be near 4200 * 60 = 2,46,000.

    So what have I managed? I have gained 50,000 more profits and avoided future taxes. How?
    Gains due to resetting = 2,96,000 (3,00,000 gains realised – 4000 CL on 3rd year)
    Gains without Rest = 2,46,000 (unrealised)

    Few more points.
    1) We will get a bad year or sideways year once every 3 years or so which will give us opportunity to reset units older than 2 years or so
    2) In case of SIP there is good chance we will not have many left over units every year to sell and buy again meaning CG accumulated every year can be realised every year
    3) It is possible for FM to increase this exempt CG to higher limit every 4-5 years which is when we may exceed the 1,00,000 limit by a large margin and we may need higher exemption.
    4) Your calculation of 25 or 50 Lac invested already is not applicable for an SIP investor like me and many others

  19. Pattu,
    Couple of things stand out from your calculations above.
    1) The NAVs used in your calculation starts at 118 and increases to 2615 in just 13 years, a CAGR of 25%. Really? I thought you wanted us to expect 12% return from equities. But if we are to get 25% returns over 13 years, we will readily pay the 10% tax on it.
    2) The NAV movement considered from 118 to 2615 has just 1 meaningful dip in 13 years. Given where we are today (near all time highs) we will certainly have more than one bad year over next 13 years which will in turn moderate the returns to 12% and help us reset a lot of older units.

    My point is,
    1) Annual LTCG reset helps book profits every year which may increase the overall returns assuming we will have several ups and downs over long term (This is not timing the market, but it might come as a side-effect of the reset exercise)
    2) I believe the 1 Lac CAGR limit will get revised upwards once every few years such that after 10 years this limit might be 5 Lac which will help us do higher resets
    3) If a 0.5% lower expense cost in a MF is going to give us higher returns, this exercise will also do the same.

    I believe for the sake of downplaying annual LTCG reset, you have chosen to go with high return low volatile bull market numbers to prove your point.
    So we must be smart enough to use this 1 Lac LTCG reset every year when possible and just like how we believe equity will give us 12-14% returns we must believe the reset will add to our returns as well as save taxes.

    Clearly there is no cost to what we need do here. So why not do it?

    1. “The NAVs used in your calculation starts at 118 and increases to 2615 in just 13 years, a CAGR of 25%. Really?”
      ===> Yeah really! That is actual data. And context matters. I am not talking risk vs reward here. Just took the first set of returns that I had.
      2) The NAV movement considered from 118 to 2615 has just 1 meaningful dip in 13 years. Given where we are today (near all time highs) we will certainly have more than one bad year over next 13 years which will in turn moderate the returns to 12% and help us reset a lot of older units.
      ===> okay then
      “1) Annual LTCG reset helps book profits every year which may increase the overall returns assuming we will have several ups and downs over long term (This is not timing the market, but it might come as a side-effect of the reset exercise)”
      ===> okay then

      2) I believe the 1 Lac CAGR limit will get revised upwards once every few years such that after 10 years this limit might be 5 Lac which will help us do higher resets
      ===> No we will get an exemption of 50 lakh

      3) If a 0.5% lower expense cost in a MF is going to give us higher returns, this exercise will also do the same.

      ===> Does the data show there is NO benefit?!! It is a matter of perception about what is a big gain or small gain.

      I believe for the sake of downplaying annual LTCG reset, you have chosen to go with high return low volatile bull market numbers to prove your point.

      ===> Okay believe what you like.

      So we must be smart enough to use this 1 Lac LTCG reset every year when possible and just like how we believe equity will give us 12-14% returns we must believe the reset will add to our returns as well as save taxes.
      Clearly there is no cost to what we need do here. So why not do it?

      ==== Good luck

  20. I find your article detailed and informative.But for ordinary and small investor like me it’s not easy to digest.
    My just one question is that for small investor who invest through STP route regularly and investing fir really long term ,do it beneficial to redeem and reinvest yearly so as to reset LTCG ? Thanks

  21. I am wondering the same thing. My way of reset would also be to redeem all units and buy back immediately. I hope the author would shed some light on the difference it would thereby make to calculations.

  22. Plain answer means To reset or not to reset for a investor who wish to invest really long and in systematic manner and goal wise.Only redeeming his corpus when he reaches his desired goal.

    1. Thank you for finding the article detailed and informative and for explaining what a plain answer means. Would you have asked this question if you did not find the details and information in the article? Would have trusted someone blindly if they said without any data: reset or not?! If you would have, there are plenty of experts who do that in the media. Please consult them. If your definition of plain answer means without proof, you are in the wrong place. Good day.

  23. Hi.
    “””Where is the tax saving? the 1L represents a tax free limit. There is no saving if you reset up to 1L (or more)! “””

    ——- Potential future tax is saved by resetting upto 1 lac free limit. For Example. If I reset fund value of 6 lac on which my LTCG is 1 lac, I am booking the profits right now. In future I will pay less tax if I reset upto 1 lac LTCG every year.

    Regards, Manish

  24. sir why did you reset so less amount in all examples when you can reset 1 lakh worth of gains each year?

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