How to harvest tax-free capital gains from stocks and equity oriented mutual funds?

You have only two trading days to do this to pocket ₹1 lakh tax-free gains from stocks and equity oriented mutual funds.

With the BSE Sensex rising 26% and the midcap and smallcap indices shooting up more than 60% in the past one year, most stock investors saw their portfolio grow during the financial year. Long-term capital gains from stocks and equity oriented mutual funds are now taxed at 10%. However, under section 112A, long-term capital gains of up to ₹1 lakh from equity and equity oriented mutual funds are tax free in a financial year.

If you are sitting on handsome profits, it may be a good idea to optimise your tax by harvesting some of the gains. This is true even for long-term investors. Instead of accumulating long-term capital gains for several years and booking profits at one go, they can reduce their tax liability by booking profits of up to ₹1 lakh every year.

Here’s how it works. Suppose you are holding 500 shares of NTPC bought more than one year ago at ₹150. The current price is ₹330, which means your investments have grown by ₹80,000. If you sell these 500 shares before 31 March, you will book a profit of ₹80,000 for the financial year 2023-24. This is tax free money. After these stocks have gone out of your demat account, you can buy them back again. Assuming you buy 500 shares back at ₹335, your cost of acquisition will now get reset at a higher level for tax purposes.

What happens if you don’t sell now and continue to hold them for the long term. Let us assume NTPC stock price goes up and you sell the shares at a higher price of ₹500. In that case, the ₹1.75 lakh long-term gains you will get will not be completely tax free. Only ₹1 lakh will be tax free while the remaining ₹75,000 will be subject to 10% tax. However, if you harvest the ₹80,000 gains now and buy back NTPC shares, you will be able to get the tax free gains again when you sell at ₹500.

The same can be done for mutual funds as well. If your investments have completed one year, just sell the equity funds and buy them back again. If you want to do this with the same stock, you must wait for the shares to go out of your demat account before buying them back. In case of mutual funds, wait for the sale transaction to be complete before buying the mutual fund scheme again.

Some investors may not have been lucky with their stock and fund investments. They should book losses and adjust them against gains from other investments. Losses in one investment can be adjusted against gains from other investments. However, keep in mind that long-term capital losses can be set off only against long-term capital gains. But short-term capital losses can be set off against short-term or long-term capital gains. It is important to keep an eye on the calendar when you do this.

Make sure you sell shares and mutual fund units that were bought more than a year ago. Only long term capital gains are eligible for the ₹1 lakh tax-free limit. Short-term gains on shares and units bought less than a year back will be subject to 15% tax.

Also, make sure that you haven’t already breached the ₹1 lakh tax free limit through other transactions. For this, you must know your capital gains for the year before you get into this. Log on to your mutual fund or brokerage house and get a capital gains statement. Mutual fund transfer agency Computer Age Management Services provides a consolidated statement across all funds. Also check your Annual Information Statement on the income tax portal to see if you have made other long term capital gains during the year.

This tax harvesting strategy does not imply that you reduce your allocation to equities. The allocation would reduce only if you sell your stocks and equity funds but don’t buy them back. Harvesting of gains only involves selling off some stocks and funds and buying the same stocks a day or two later. Your asset allocation will not change.

Sudhir Kaushik, CEO of tax filing and financial wellness portal TaxSpanner.com