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    How to take advantage of LTCG tax harvesting for your mutual funds

    How to take advantage of LTCG tax harvesting for your mutual funds

    How to take advantage of LTCG tax harvesting for your mutual funds
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    By Tushar Jain   IST (Updated)

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    The ghost of long-term capital gains (LTCG) tax came back to haunt the equity investors in India in the year 2018.

    The ghost of long-term capital gains (LTCG) tax came back to haunt the equity investors in India in the year 2018.
    Till some time back, many of us were anticipating the abolition of LTCG tax. Unfortunately, in the recently concluded budget for the year 2019, the government has neither abolished LTCG tax nor raised the exemption limit of Rs 1,00,000 per year.
    While we now have to live with LTCG tax for another year, it’s time we explore the benefits of tax harvesting and how it can help us reduce our LTCG tax outlay.
    What is Tax Harvesting?
    Tax harvesting is an age-old concept of selling and buying of the same security to realize or “harvest” the returns. As a result, one can offset the gains against the losses/exemption limits, thereby reducing one's tax liability and increasing post-tax returns.
    Let’s understand this concept from the perspective of a person who is invested in the Indian stock market through equity mutual funds. Three things are extremely important to consider before this person considers tax harvesting:
    • The holding period for his mutual fund investments (either in part or in full) should be greater than 12 months (which is the definition of long term duration).
    • There should be price appreciation (hence a long term capital gain) on his holding.
    • There should be minimal to no transaction charges or brokerage. If these charges are high, it will increase the cost of switching of mutual funds thus reducing the impact of tax harvesting.
    • Understanding the Maths Behind LTCG Tax Harvesting
      The basic idea of LTCG tax harvesting is to sell the units that are eligible for LTCG and buying them back at the current market price.
      This results in increasing your acquisition cost (of intermittent units), thus reducing the LTCG rupee amount in the redemption year, but without any impact on the final asset value.
      Here’s a very simplified example of how this concept works in practice.
       
      With a lump sum amount of Rs 300,000 growing at a rate of 10 percent over a 5 year period, there is no tax outlay if you harvest your returns each year. This is against the Rs 8,000 plus LTCG tax you would have to pay in case of non-harvesting.
      While this is an oversimplified example, any increase any of the variables (initial investment, rate of growth or time frame) and introducing more variables (like monthly SIPs) will impact the tax outlay even further. Thus, tax harvesting in instrumental in increasing post-tax gains on your equity and mutual fund investments.
      When Should You Plan For Tax Harvesting?
      Once the holding period of your equity/mutual fund (in part or in full) is greater than 12 months, you should consider harvesting. If the duration is less than 12 month, the investment will not qualify for long term capital gains. In fact, it will incur a steep short-term capital gain (STCG) of 15 percent. Plus if you are invested in mutual funds, there may be exit loads applicable if you redeem before 12 months.
      How Can You Plan LTCG Tax Harvesting?
      If you are a do-it-yourself investor, you can also undertake tax harvesting by yourself. However, as the number of securities in your portfolio increase, it may become time-consuming to keep a record of all transactions and identifying the ones which qualify for LTCG exemption.
      And it becomes even more complicated with swings in the market, coupled with an investment made through SIPs but redeemed as a lump sum. In such scenarios, you should invest in mutual funds through new fintech startups like Kuvera which not only help you invest in direct mutual funds but also offer LTCG tax harvesting options using sophisticated algorithms.
      Conclusion
      Savings due to LTCG tax harvesting might seem small at the first look.
      However, as your portfolio builds and the wealth accumulation period increases, these small amounts can quickly add up to become big numbers.
      And if the tax on long term capital gains is going to stay for a couple of more years, it makes all sense to harvest your gains earned from equity investments, specifically mutual funds.
      Tushar Jain is a personal finance enthusiast who loves to talk about money, savings, investments and spending. He blogs about financial wisdom and income growth habits at https://jaintushar.com/
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