How to use MF, stock losses to reduce your tax burden (tax-loss harvesting)

Here is how investors can legally reduce their tax liability from capital gains by exploiting recent losses in stocks, equity or non-equity mutual funds

Image of a glowing light bulb with a person pointing to it representing an idea of how to use mutual funds stock losses to reduce your tax burden (tax-loss harvesting)

Published: March 22, 2020 at 9:27 am

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Investors can legally reduce their tax liability from capital gains by exploiting recent losses in stocks, equity or non-equity mutual funds. Here are the rules of tax-loss harvesting with easy-to-understand examples. While the last week of the current financial year offers one last chance for tax-loss harvesting,  the rules of capital loss set off against capital gains as explained in this article are always valid.

About the author: Sriram Jayaraman is a SEBI registered fee-only Investment adviser. After 27 years of working in large IT companies in India, he achieved financial independence and retired early to become a fee-only advisor. You can contact Sriram via his website arthagyan.com

Let us start with some basic definitions for Income Tax. You can skip this section if you are familiar with the income tax terminology.

  • Equity mutual fund this invests 65% or more in equity shares of listed Indian companies to be categorized as an equity mutual fund for income tax purpose.
  • Non-equity mutual funds all other funds are referred to as non-equity funds and these include debt funds, gold funds, fund of funds and international funds
  • A non-equity mutual fund sold before 3 years from the date of buy is classified as short term holding. If it is sold on or after 3 years, it is termed as long term holding. The holding period is reduced to 1 year for equity mutual fund for the classification. So An equity fund held for less than 1 year is short term holding and 1 year or more is long term holding.
  • A profit arising from a short term holding is termed as short term capital gain or A profit arising from a long term holding is named Long term capital gain or LTCG.
  • A loss arising from a short term holding is short term capital loss or STCL and the loss from long term capital holding is long term capital loss or LTCL.
  • The taxation rates is below:
Equity MF/Stocks Non-equity MF
STCG 15% Individual tax rate
LTCG 10%, no tax up to Rs. 1 Lakh 20% with indexation benefit

How can this capital gain be lowered or set off?

Short term capital loss (STCL) can be set off against the STCG or LTCG. However Long term capital loss (LTCL) can be set off against only LTCG.

Let us take an example to understand this. Case 1: Akash has invested Rs. 20 Lakhs in SBI Bluechip fund Direct-Growth on 12 Jun 2018. He sold it on 20 Jan 2020.

illustration of long term capital gains to be offset with long term capital loss for tax-loss harvesting
illustration of long term capital gains to be offset with long term capital loss for tax-loss harvesting

Is there a way for Akash to save the tax in the current environment when his equity mutual fund investments are at a notional loss? The answer is yes if he has a loss of Rs. 91,909 on another mutual fund, he can set it off against the LTCG of Rs. 91,909.

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This is called tax-loss harvesting: converting notional losses to real losses to offset tax from realised capital gains in a financial year.

He had bought UTI Nifty index fund Dir Growth at NAV 80.15 on 22 Jan 2020, an investment amount of Rs.10 lakhs. The present value of this at NAV 54.67 is Rs.  6,82,096. The notional loss is Rs. 3,17,903. Akash can sell a portion of his holding in this fund at a loss equal to Rs. 91,909. Once he has booked this loss, there is no further tax liability. He is free to re-invest the redemption proceeds into the same fund or a different fund.

Case 2: Ravi has invested in Franklin Low duration fund 2.5 years back. He likes to hold it till the completion of 3 years so that the indexation benefit can be used. However, the fund performance has been pathetic for the last few months with a few defaults hitting its NAV. However, if he sells out, he will need to pay STCG on the gains which he wants to avoid. How can he achieve this? He is also invested in HDFC index nifty fund which he has purchased within 1 year is at a notional loss to him. He can sell both of them. The STCG on the Franklin low duration fund can be set off against the STCL on the HDFC index nifty fund.

Case 3: Navin had purchased Quantum long term equity fund at a NAV of 51.15 on 11 Oct 2018. He decided to redeem it. He managed to redeem it on 19 Mar 2020 at a NAV of 36.36. Thereby his investment of Rs. 5 lakhs has resulted in an LTCL of Rs. 1.44 Lakhs. He has an STCG of Rs. 1.5 Lakhs from the sale of debt mutual funds. Can he use the STCG to set off the LTCL? No. This is not permitted as per income tax rules. He can set off the LTCL only against LTCG, not STCG. He cannot set off the LTCL against any other heads of income such as salary. He can, however, carry forward the LTCL for a maximum period of 8 years. If he makes an LTCG of 1.44 Lakhs in any of the future 8 years, that can be set off against the current LTCL.

I have discussed only a few cases in this writeup. More examples are available as tutorials at the Income Tax website.

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17 Comments

  1. Thanks for posting this article. One small clarification required regarding the difference in Transaction date and settlement date, which is T+2 for stocks and T or T+1 for mutual funds. Is it correct that transaction date is used for taxation purpose when these two dates fall in different FY.

  2. Thank you for this. Im planning to set-off stcg in liquid fund with stcl of nifty.
    Great timing of the post as always.

    1. Can stcg of debt fund be really offset with stcl of equity or stocks?
      I thought its not possible because they have different tax rates individually.

  3. In long run, I dont understand how this is saving on tax. If I decide to sell my MF units at loss, I pay less tax. But usually people sell to reinvest when markets are recovering and when they again make good profits from recovered market they again will end up in huge tax from huge increase in capital gains from recovered market. Then how can it be tax saving overall?

    1. You are correct and your point is spot on. If you book loss and re-invest, you will be entering the stock or fund at a lower lever. When you finally sell it, the taxation at that time will come into the picture. This will only postpone the taxation. We can always hope that LTCG gets reduced later!

      1. But the problem is the person will loose indexation benefit and may end up in little higher tax if he pulls out and reinvest (correct me if I am wrong), also India is more or less following in USA in taxing equity. I believe if India follows US it becomes even more complicated as in US LTCG is based on slab system.

  4. Are you saying STCL can be used to do tax-loss harvesting even if one has LTCG ? For e.g. if one has 5 lacs of LTCG and 2 lacs of STCL, the STCL can be used to reduce the tax liability on 5 lacs ?

      1. A follow up question is that the 2 Lacs of STCL in the above e.g. need not get carried forward for 8 years but can be adjusted in the same year against LTCG of 5 lacs?

  5. Hi sir,
    I recently sold units in Mirae Asset Emerging Bluechip fund expecting that there would be long term capital loss. To my surprise, the capital gains report published by the AMC shows capital loss as 0, though I incurred capital loss. The AMC is not correctly showing the capital loss. You might want to say that in this article as you had mentioned in your previous articles to calculate capital gains on our own.
    I found this in both ICICI as well as Mirae. They’re showing everything correctly except LTCL.
    In your examples above, this comes under case 3.

  6. Hi sir,
    I recently sold units in Mirae Asset Emerging Bluechip fund expecting that there would be long term capital loss. To my surprise, the capital gains report published by the AMC shows capital loss as 0, though I incurred capital loss. The AMC is not correctly showing the capital loss. You might want to say that in this article as you had mentioned in your previous articles to calculate capital gains on our own.
    I found this in both ICICI as well as Mirae. They’re showing everything correctly except LTCL.
    In your examples above, this comes under case 3.

    1. Does this year’s income calculation remain from April 2019 to march 2020. I understand that tax savings has been pushed to June , but do other income assessment s remain at March 31st

  7. This article is useful, but there are some risks that the readers should be aware of while harvesting gains or loss of MF.

    First of all one should check if it’s worth paying the exit load for the loss that you are harvesting. If your loss is 30k and exit load is 1k and if you have 30k gains from a debt fund then paying 1k to save the tax on this gain makes sense.

    I could think of these 2 risks which applies if anyone just wants to harvest notional loss or gain but don’t want to exit the MF altogether.

    NAV fluctuation risk :
    Obviously you would want to sell the fund and buy the fund same day, so that effectively you would pay only exit load if any to harvest losses. Avoid doing this in times when market is highly volatile. For example, you invested 3L on a fund now it quotes 2L, you decide to harvest the loss, now if you sell the fund for 2L and buy the same fund for 2L, you would end up paying 3k in general for exit load to harvest 1L loss. If things go bad, like payment was not confirmed by the exchange same day then next days NAV will be used to process your buy order, if market goes up on the day the buy order is processed then you will lose money. In this week itself market has moved up and down anywhere between -10 to +10% in a single day. This will create situation where it’s not worth harvesting the gain/loss.

    Suppose if you don’t have liquid cash equivalent in your account to buy and sell on the same day, forget about harvesting.

    Technical glitch :
    If you are using 3rd party platforms to buy Mutual funds, there is an additional layer where your sell/buy order can fail.

    I somehow feel it’s better to do this on respective mutual fund website directly to avoid 3rd party software glitches.

    Note that it’s always better to do this harvesting in chunks of less than 2L. MF companies will confirm the buy order same day for the amount less than 2L , they don’t wait for payment confirmation from bank/exchange, this will reduced the risk of delayed execution.

  8. This article is useful, but there are some risks that the readers should be aware of while harvesting gains or loss of MF.

    First of all one should check if it’s worth paying the exit load for the loss that you are harvesting. If your loss is 30k and exit load is 1k and if you have 30k gains from a debt fund then paying 1k to save the tax on this gain makes sense.

    I have noticed 2 kinds of risks which applies if anyone just wants to harvest notional loss or gain but don’t want to exit the MF altogether.

    NAV fluctuation risk :  Obviously you would want to sell the fund and buy the fund same day, so that effectively you would pay only exit load if any to harvest losses.  Avoid doing this in times when market is highly volatile. For example, you invested 3L on a fund now it quotes 2L, you decide to harvest the loss, now if you sell the fund for 2L and buy the same fund for 2L, you would end up paying 3k in general for exit load to harvest 1L loss. If things go bad, like payment was not confirmed by the exchange same day then next days NAV will be used to process your buy order, if market goes up on the day the buy order is processed then you will lose money. In this week itself market has moved up and down anywhere between -10 to +10% in a single day. This will create situation where it’s not worth harvesting the gain/loss.  Suppose if you don’t have liquid cash equivalent in your account to buy and sell on the same day, forget about harvesting.

    Technical glitch : If you are using 3rd party platforms to buy Mutual funds, there is an additional layer where your sell/buy order can fail. 
    I somehow feel it’s better to do this on respective mutual fund website directly to avoid 3rd party software glitches. 
    Note that it’s always better to do this harvesting in chunks of less than 2L. MF companies will confirm the buy order same day for the amount less than 2L , they don’t wait for payment confirmation from bank/exchange, this will reduced the risk of delayed execution. 

  9. In case of selling shares, the proceeds from the sale can be considered (and adjusted) for any buy on the same day.
    How is it done in mutual funds? say, if I sell 100 units of a fund and buy the same 100 units of same fund. In this case, should I set aside funds for the buy portion? of it can be adjusted against the “sell” portion?

  10. Please consider the following case:
    LTCG on equity mutual fund = 100,000
    Carried Forward LTCL on equity MF = 90,000
    Can I carry forward the LTCL of 90,000 for the
    Next year , since 100,000 of LTCG on equity MF is allowed free of tax ?

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