Most investors end a financial year with some holdings in profit and some at a loss. Tax-loss harvesting is the practice of selling loss-making holdings before the year ends so that the loss can be set against gains, reducing the tax payable.
Done carefully, it is a legitimate way to pay tax only on your net gains. Done carelessly, it can backfire. This article explains how it works under the Indian rules in broad terms, works through an example, and sets out the traps, including one that catches many people: selling and buying back on the same day.
The idea in one paragraph
Capital gains tax is charged on gains you realise by selling. Losses you realise can, within limits, be set off against those gains. If you hold a share bought at 500 that now trades at 400, the loss of 100 exists on paper but does nothing for your tax until you sell. Selling it realises the loss, which can then reduce the taxable gains you made elsewhere during the year.
If you still like the investment, you can buy it back later, so your holding is broadly restored, now with a lower purchase price. In effect, you have converted a paper loss into a tax benefit today, in exchange for a smaller loss to claim, or a larger gain to pay, when you eventually sell for good.
How set-off works, in broad terms
Under current rules, gains and losses on listed shares and equity funds are split into short-term and long-term, based on how long you held the investment.
Short-term capital losses can be set off against both short-term and long-term capital gains.
Long-term capital losses can be set off only against long-term capital gains.
Unused losses can be carried forward to later years for a specified number of years, but only if you file your income tax return on time and report them. A late return can forfeit the carry-forward.
Long-term gains on listed equity also have an annual exemption up to a limit, above which tax applies. That exemption shapes how useful harvesting is: if your long-term gains for the year are already within the exempt amount, harvesting long-term losses saves nothing this year, though the losses may still be carried forward.
Holding periods, rates, the exemption limit and set-off rules are set by tax law and revised from time to time. Check the current position, or ask a tax professional, before acting.
A worked example
Illustrative only, ignoring charges. During the year an investor has sold some shares for a short-term gain of 60,000. They still hold another stock bought for 2,00,000, now worth 1,60,000, held for less than the long-term period, a paper loss of 40,000.
Without harvesting: the taxable short-term gain is 60,000.
With harvesting: before the year ends, the investor sells the losing stock, realising a short-term loss of 40,000. Net short-term gain becomes 20,000. The tax on 40,000 of gains is avoided this year.
If the investor still wants to own the stock, they buy it back on a later trading day at around 1,60,000. Their new purchase price is 1,60,000 rather than 2,00,000. If it later recovers to 2,00,000 and they sell, they will have a gain of 40,000 to report then. So harvesting often defers tax rather than eliminating it, though deferral itself has value, and a later gain may fall into a different category or year.
The traps
Selling and buying back the same day. If you sell and repurchase the same quantity of the same share on the same day, the exchange nets the two trades and they are treated as an intraday trade, not a delivery sale. Intraday equity trades are taxed as speculative business income, not capital gains, and the loss may not be usable against your capital gains at all. Buy back on a later trading day, after the sale has settled.
Price moves while you are out. Between selling and buying back, the price can rise. A small tax saving can be wiped out by missing a sharp rebound.
Resetting the holding period. Buying back starts a fresh holding period. A position that was close to becoming long-term restarts as short-term, which can change the tax on a future sale.
Costs. Brokerage, securities transaction tax, stamp duty and the spread on both trades reduce the benefit. On small losses, the costs can exceed the tax saved.
Substance over form. India currently has no specific rule like the wash-sale rules of some countries, but tax authorities can question transactions that exist only to create a loss. Keep the purpose and records clear, and take professional advice for large amounts.
Exit loads and lock-ins on funds. Selling fund units may attract an exit load, and tax-saving fund units cannot be sold during their lock-in.
When it is worth doing, and when it is not
Worth considering when you have meaningful realised gains this year, a holding with a real loss of a size that saves more tax than the round-trip costs, and you are comfortable being out of the position for at least a day.
Also useful when you wanted to sell a poor holding anyway. If you have lost confidence in an investment, selling before the year ends gives you the tax benefit as a by-product of a decision you would make regardless.
Not worth it for tiny losses, when you have no gains to offset and no likely gains in the carry-forward period, or when the trade would distort a carefully built allocation.
Harvesting gains is the mirror image. Some investors with long-term gains within the annual exemption sell and buy back to raise their purchase price, using the exemption each year. The same same-day trap and cost considerations apply.
Don't let the tax tail wag the dog. Investment decisions should come first; tax optimisation is a refinement, not a reason to trade.
An account with a tax profit-and-loss report
Check short-term and long-term gains and losses before the year ends. Free to open
Tax rules, holding periods, rates, exemptions and set-off provisions are set by tax law and change from time to time; check the current rules or consult a tax professional before acting. This is educational material, not tax or investment advice. We run no tips group and no signal service, we manage nobody's money, and no return is promised.
Disclosure: the account-opening link on this page is under Atul Shrivastava's Zerodha Authorised Person registration (NSE AP Reg: AP2516003481; Zerodha Broking Ltd. SEBI Reg: INZ000031633) and earns a revenue share. TheFinBaba is not a SEBI-registered Investment Adviser — this content is educational, not investment advice.
Frequently Asked Questions
What is tax-loss harvesting?
Selling investments that are at a loss before the financial year ends so the realised loss can be set off against capital gains, reducing the tax payable.
Can I sell and buy back the same share on the same day?
Doing so is treated as an intraday trade, taxed as speculative business income rather than capital gains, so the loss may not offset your capital gains. Buy back on a later trading day.
Can long-term losses be set off against short-term gains?
Under current rules, long-term capital losses can only be set off against long-term gains, while short-term losses can be set off against both. Check the current rules before acting.
Can unused capital losses be carried forward?
Yes, for a specified number of years under current rules, but only if the income tax return is filed on time and the losses are reported.
Does tax-loss harvesting save tax permanently?
Often it defers tax, because buying back lowers your purchase price and increases a future gain. Deferral still has value, and the later gain may be taxed differently.
Related Reading
- Tax-efficient savings through salary
- Holdings sitting near their lows
- Short-term and long-term gains explained
- How trading income is taxed differently
- A year-end look at every holding
- Units locked in for tax saving
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
