Summary of this article
Tax-gain harvesting in mutual funds means voluntarily booking LTCG up to the tax-free limit every year.
Tax-gain harvesting can help you reduce your taxes significantly.
If you redeem the units but don’t reinvest, the strategy becomes meaningless.
The end of the financial year is when most investors start thinking about rebalancing their portfolios and planning for taxes. But there is one simple, often ignored technique that can meaningfully reduce how much you ultimately pay, without changing your investment strategy. Tax harvesting, used correctly, can help investors reduce the tax liability on mutual funds to a great extent.
What is Tax-Gain Harvesting?
Tax-gain harvesting means voluntarily booking long-term gains up to the tax-free limit every year, instead of letting them accumulate untouched for several years.
Long-term capital gains (LTCG), that is, gains on investments held over 12 months on equity and equity mutual funds, are tax-free up to Rs 1.25 lakh per financial year. Anything above that attracts 12.5 per cent tax.
Most investors let gains compound inside the fund for years. The problem: when you eventually sell, you may end up with very large long-term gains and pay a much bigger tax bill in one shot.
Tax-gain harvesting helps you reduce your taxes significantly. Or, if you are a small investor with no big sums, tax harvesting could help you bring your tax outgo on equity funds to zero.
Imagine you have investments in equity mutual funds. Your investment of Rs 3 lakh in a mutual fund has made Rs 80,000 gains during the financial year. Your gains are well under the tax-free limit of Rs 1.25 lakh during the financial year. If you sell your investments, book Rs 80,000 profit, you pay no tax. And then invest Rs 3 lakh plus Rs 80,000 profit back into the fund immediately. Here, you achieve two things:
You reset your cost price to today’s level.
You lock in tax-free gains that would've been taxable later.
You slowly harvest gains every year within the exemption limit instead of letting them snowball into a large taxable amount.
This method can be used even when you are investing via a systematic investment plan (SIPs). You can redeem units that you have held for more than 12 months and reinvest. However, if you redeem the units but don’t reinvest, the strategy becomes meaningless; in fact, it hurts compounding and, in turn, pulls down your long-term returns.
What is Tax Loss Harvesting?
Tax-loss harvesting is when you sell investments at a loss to offset your taxable gains for the year. If your equity gains exceed the Rs 1.25 lakh tax-free limit, harvesting a loss helps bring the net taxable number down.
For instance, if your total LTCG this year is Rs 2 lakh. Tax-free limit for equity mutual funds during the financial year stood at Rs 1.25 lakh. So, taxable gains stood at Rs 75,000.
Now, assume a fund in your portfolio is showing a loss of Rs 40,000. If you sell that loss-making fund, your taxable gain drops from Rs 75,000 to Rs 35,000 (Rs 75,000 minus Rs 40,000).
Now, here again, if you believe in that fund, you can buy that fund again immediately.
To sum up, tax harvesting is not complicated and does not require market timing. A few deliberate actions each year can keep your tax bill lighter and your long-term returns healthier, exactly what smart investing should achieve.
