Tax-Loss Harvesting
Tax-loss harvesting is the practice of deliberately realising losses on investments that have declined in value in order to offset capital gains elsewhere in the portfolio, thereby reducing the overall tax liability for the financial year.
Tax-loss harvesting is a legitimate and commonly overlooked tax efficiency strategy. Under the Indian Income Tax Act, short-term capital losses (from assets held under 12 months for equity, under 24 months for real estate, etc.) can be set off against short-term capital gains, and long-term capital losses (from equity or equity mutual funds, for instance) can be set off against long-term capital gains. Any unabsorbed losses can be carried forward for up to 8 assessment years to set off against gains in future years.
The mechanics are straightforward. Suppose an investor holds shares of Company A that have risen 40% (unrealised gain) and shares of Company B that have fallen 30% (unrealised loss). If both positions were held for over 12 months, they qualify as long-term. By selling Company B before 31 March (end of the financial year) and booking the long-term capital loss, the investor can offset LTCG on Company A, reducing the tax payable at the 12.5% LTCG rate (applicable from FY2024-25).
Critically, the investor is not required to exit Company B permanently. After booking the loss, they can reinvest in the same stock after a brief period (many advisors suggest waiting for price stabilisation or at least ensuring the transaction is not seen as a wash sale—though India's tax law does not have a formal wash sale rule unlike the US). However, the act of selling and rebuying resets the cost basis and holding period, which must be factored into future tax calculations.
Within mutual funds, tax-loss harvesting is relevant for investors who own both equity and debt funds with varying performance profiles. In volatile years, a portfolio review in January–February of each financial year allows time to identify loss-booking opportunities and strategically realise them before 31 March.
Limitations include transaction costs (brokerage, STT, stamp duty) that reduce the net benefit, the risk of missing a sharp price recovery while waiting to re-enter, and the fact that losses in derivatives (speculative transactions) cannot be set off against regular income—only against future derivative gains.