Tax harvesting can reduce tax outgo. Is it worth it now?

The Union Budget 2024-25 raised the tax rates on gains from equity investments. As a result, investors are eyeing tax-saving strategies more than ever to protect their gains and keep more of their hard-earned money. One such strategy is tax harvesting. But what exactly does this involve, and is it worth considering with the new tax rates? We'll explore in this article.

Understanding the new tax rates

Before we get into tax harvesting, let's understand the new tax rates on equity investments. Previously, long-term gains (gains from investments held for more than 12 months) were taxed at 10 per cent, and short-term gains (gains from investments held for less than 12 months) attracted a 15 per cent tax. The new budget has increased these rates to 12.5 per cent for long-term gains and 20 per cent for short-term gains.

On a brighter note, the tax-exempt limit for long-term capital gains (LTCG) has been increased from Rs 1 lakh to Rs 1.25 lakh.

What is tax harvesting?

The term has a professional sound to it. In the world of mutual funds, harvesting either means selling its underperformers to offset the gains or using the tax-free threshold of Rs 1.25 lakh to minimise your long-term tax.

Confused? Here's an example: if you sell gains of up to Rs 1.25 lakh from a mutual fund held for over a year and immediately reinvest the amount in the same fund, it helps you reduce your overall tax burden.

Our calculation also suggests that. If you invest Rs 20 lakh as a lump sum that grows 12 per cent annually for the next 10 years, tax harvesting every year will leave you with an extra Rs 1.41 lakh than if you hadn't.

Does tax harvesting make sense?

The Rs 1.41 lakh difference from the above example may appear substantial at first glance. However, in percentage terms, the tax saved through tax harvesting amounts to just 2.26 per cent of the final investment value.

Tax harvesting also has further drawbacks.

For starters, tax harvesting is a manual and potentially confusing activity. You'll need to identify which gains are long-term and calculate how many units to sell.

Second, the savings are capped by the Rs 1.25 lakh tax-exemption limit. No matter how much your investment grows, the maximum tax saved will be Rs 15,625 (12.5 per cent of Rs 1.25 lakh) in a financial year. Additional costs like exit loads could further reduce the benefit.

Hence, a simpler, safer strategy for most investors would be to let their investments grow and compound over time without selling and reinvesting every year.

Also read: Mutual fund investors need greater tax awareness