# How Does Tax Loss Harvesting Work?

by Angel One

Can that loss-making stock you are stuck with finally come handy in saving you some taxes? Yes, it can, with tax-loss harvesting strategy and here’s how it works.

Tax-loss harvesting is a strategy where capital losses are set off against capital gains to reduce taxable profits.

This has gained momentum since April 2018, when long-term capital gains on the sale of stocks were made taxable at 10 percent over and above Rs.1 lakh. Capital gains made on assets held for less than a year (short-term capital gains) are taxed at 15 percent.

## Here’s How Tax Loss Harvesting Works

1. Identify stocks that have seen a constant decline and ones that have lost enough value that they may not recover soon enough.
2. Sell them off and book losses. The capital losses can be offset against capital gains you have made on the portfolio. Do note, long-term capital losses can be set off only against long-term capital losses, but short-term capital losses can be set off against both short-term and long-term capital gains on stocks. Investors can also buy a share from the same sector from the proceeds he received from booking the losses to maintain the sectoral balance of the portfolio.
3. Now, calculate the tax payable on the net capital gains.

## Example of How Tax Harvesting Works

Let us compare with the help of an example between two scenarios-one where we practice tax-loss harvesting and one where we don’t, to see how effective the strategy is.

In this simple hypothetical example, let us assume Mr Prakash has two stocks in his portfolio. Stock A and Stock B. He bought stock A at Rs. 400 and stock B at Rs. 600 on 1st January 2019.

On 25th March 2019, he saw stock A was trading at Rs. 250 and stock B rose to Rs. 800.

At the year-end, the price of stock A rose to Rs. 450 and stock B rose to Rs. 850.

The Short-Term Capital Gains (STCG) now stands at

Total Profits= Profit from Stock A+Profit from Stock B

=Rs. 50 + Rs. 250.

=Rs.300.

Now we will consider two scenarios, one where Mr Prakash sold off stock A whose prices had declined and in the other situation let us see what happens to the taxes when he continues to hold the stock on his books (and tax loss harvesting did not apply).

Let us see where his taxes stand without applying tax-loss harvesting strategy-

Since he did not book any losses, the capital tax would be 15 percent of the STCG or Rs. 300  that is Rs. 45.

Let us see where his taxes stood when he did harvest his losses on Stock A.

Assuming he sold off stock A and booked a loss of Rs. 150. (You can book stocks from the same sector with the money from the sale).

Then, your net gains after adjusting the capital losses from the overall capital gains, at the end of the year would be Rs. 150.

(total capital gains of Rs. 300-capital loss of Rs. 150)

Now the tax on your net capital gains @15 percent STCG is only Rs. 22.5.

### Conclusion:

Without tax-loss harvesting, your taxes stood at Rs. 45. After tax-loss harvesting, the tax amount reduced to Rs.22.5.

This way, by employing the tax harvesting strategy, you could not only reduce your tax outgo and but also get out of a potential loss-making position.