How Stock Market Corrections Can Help You Save Tax

The other indices viz. BSE Mid Cap Index and BSE Small Cap Index -- as well as sectoral indices -- have been under pressure and have fallen significantly since their respective peaks. There is a sea of red across market caps and most sectors. Those who've invested with irrational exuberance at the peak have been drenched in the blood bath and witnessed double-digit negative returns. Even those who invested at the start of FY25 have been left disappointed.

There have been a variety of factors behind this market fall mainly geopolitical tensions, tariff tantrums, weak Indian rupee against the greenback, decreased hopes of a rate cut by the U.S. Federal Reserve, slowdown in corporate earnings of India Inc., expensive valuations of the Indian equity market compared to global peers, and massive FPI selling among others.

[Read: The Key Factors Behind the Recent Volatility in the Indian Equity Market]

Many mutual fund investors and direct stock investors have faced losses or wealth erosion.

In FY25 if you too are sitting on certain notional losses in your portfolio -- whether it's equity funds or listed equity shares -- they can be converted to realised or actual losses, particularly for investments that don't seem very worthy of keeping in your portfolio.

You could book capital gains on some investments (that have built wealth over a long time) and book capital losses on some that are not so worthy and have left you disappointed. This is called capital loss harvesting or tax loss harvesting, which indirectly helps reduce tax. Not only that, but you also end up indirectly doing a portfolio cleanup and trimming down.

Capital loss can be classified into two: Short Term Capital Loss and Long Term Capital Loss. When the loss is booked within 12 months from the date of purchase of the equity mutual fund and/or listed equity shares, it will be treated as Short Term Capital Loss (STCL). Whereas if the loss is booked after 12 months of holding period on equity-oriented mutual funds and/or listed equity shares, it will be treated as Long Term Capital Loss (LTCL).

How Can You Save Tax?

The Income Tax Act, 1961 provides for set off and carry forward of capital gains against capital losses. Simply put, you offset your capital gains against the capital loss.

At a time when equity markets are rather volatile and downside risk cannot be ruled out, tax loss harvesting makes sense now at the end of the financial year.

However, the rule here is that the capital loss can be set-off only against the head 'Income from Capital Gains'. Meaning, that the capital loss set-off cannot be done against any other head of income when computing the total taxable income.

Rule for Set off of Capital Losses

As per the provision of the Income Act 1961, if there is a Long Term Capital Loss (LTCL), it can be set off only against LTCG. Also, as per the current tax rule for FY25, LTCG only if it is over Rs 1.25 lakh is taxable.

In contrast, the Short Term Capital Losses are permitted to be set off against both Long Term Capital Gains and Short Term Capital Gains.

Note that you are required to pay tax only on net capital gains. By setting off the realised capital loss against the realised capital gains during the financial year by indulging in tax loss harvesting, you could reduce your tax liability.

Rule for Carry Forward of Capital Losses

As far as the carry forward of the capital losses is concerned, in case you are not able to set off the capital losses in the same Assessment Year (relevant to the respective Financial Year), it can be carried forward up to 8 years for both STCL as well as LTCL.

Say you have an LTCG of 2.00 lakh and STCG is nil, but also have an LTCL of 50,000 and STCL of Rs 40,000; by booking these losses before 31st March 2025 and availing of a set off for the capital losses, your net capital gains shall reduce to Rs 1.90 lakh. Herein as well, the net LTCG (after applying the basic exemption limit of Rs 1.25 lakh) will reduce to Rs 25,000 (Rs 1.50 lakh - Rs 1.25 lakh) which will be taxed at 12.5% (without indexation).

In case there is a capital loss, that can be set off against the capital gains, it can be carried forward to the next financial year (for up to a maximum of 8 assessment years). That said, make sure to file the ITR before the due date, otherwise, the Income Tax Department will not permit carry forward of losses.

To make the best of the tax loss harvesting strategy, take a close look at your capital gains statement. You can source it from the website of RTAs, your distributor, broker, or online platforms you invest through.

When you are deciding on tax loss harvesting, make sure you are carefully evaluating the holding period to determine short-term or long-term as the case may be, whether for capital gains or losses.

Also, weigh the capital gains vis-a-vis the capital losses sensibly to refrain from excessive tax loss harvesting. Ideally, an optimal set-off should be done.

Tax Loss Harvesting When Done Sensibly Adduces These Seven Benefits:

1) Reduces your tax liability on capital gains

2) Facilitates portfolio review and rebalancing

3) Culls off underperforming and unsuitable investments

4) Ensures you hold well-performing investments

5) Declutters the portfolio

6) Frees cash (which could be redeployed back into promising asset classes)

7) Helps optimally diversify the investment portfolio

That being said, when you are indulging in Tax Loss Harvesting, it's important to not lose sight of your asset allocation (i.e. money deployed into equity, debt, and gold).

If your asset allocation is right, investments are aligned accordingly and are performing well, it could ensure that you are on track to achieve the envisioned financial goal/s.

[Read: Why You Need to Be Mindful of Asset Allocation in 2025 and Beyond]

To sum-up...

If a prudent approach to loss harvesting is followed, it can prove strategic and help you legitimately save tax.

In the current market conditions where volatility has intensified, and small caps and mid-caps, in particular, seem vulnerable to drawdowns, reviewing your portfolio from a loss harvesting standpoint makes sense. It would help clean up your investment portfolio and save tax. Keep in mind that, a penny legitimately saved from tax is a penny earned.

"In this world nothing is certain but death and taxes" - Benjamin Franklin

Happy Tax Planning and Investing!

Note: This write-up is for information purposes and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully before investing.

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Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.

This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.