Most investors obsess over what to buy and when to sell.
Very few spend time thinking about how much tax they’ll pay after making profits.
And that’s where returns quietly get eaten.
In India, equity gains are taxed whether you’re a long-term investor holding stocks (12.5% LTCG beyond ₹1.25 lakh) or an active trader booking intraday profits (taxed as business income at slab rates). If you ignore tax planning, you may end up paying more tax than necessary or even leave money on the table that could have been yours.
One of the ways to do that is through tax loss harvesting, which is a simple and legal way to reduce that tax burden.
What is Tax Loss Harvesting?
It involves strategically booking losses in your portfolio so that they can be set off against taxable gains, lowering your overall tax liability without changing your long-term investment view.
It’s a provision clearly allowed under India’s Income Tax Act and one that many retail investors and traders simply don’t use.
For equity investors, mutual fund holders, ETF investors, and even F&O traders, tax loss harvesting can help:
- Reduce capital gains tax
- Improve post-tax returns
- Clean up underperforming positions
- Plan exits more efficiently, especially toward the end of the financial year
In short, losses can actually help you save actual money in the form of taxes.
How to Exercise Tax Loss Harvesting?
Tax loss harvesting is the practice of intentionally selling investments at a loss in order to reduce the tax you pay on profits made elsewhere in your portfolio.
In simple terms:
- You sell your holdings that are currently trading below your purchase price
- That loss is used to offset taxable gains from your profits
- Your net tax liability comes down
This works because India’s tax laws allow investors and traders to set off capital losses against capital gains, subject to certain rules.
A key point to understand here is the difference between paper losses and realised losses.
- A paper loss exists only on your screen. It has no tax value. For example, you bought a stock at ₹1,000; it’s trading at ₹700, but since you haven’t sold it, the ₹300 loss exists only on your screen and has no tax value.
- A realised loss occurs only when you actually sell the asset, and only realised losses can be used for tax set-off. If you bought a stock at ₹1,000 and sold it at ₹700, booking a ₹300 loss that can be used to reduce taxable gains.
Tax loss harvesting does not mean exiting the market permanently or giving up on your investment thesis. In practice, investors often book losses as part of portfolio rebalancing, strategy shifts, or tax planning and then buy back the same security (after selling) to stay invested in the market while still capturing the tax benefit.
It’s also important to be clear about what tax loss harvesting is not:
- It is not fake or artificial loss creation
- It is not circular trading
- It is not tax evasion
Before we go deeper into set-off rules and examples, it’s important to quickly revisit how capital gains are taxed in India because the way losses can be used depends entirely on this structure.
Capital Gains in India — STCG vs LTCG (Quick Refresher)
To understand how tax loss harvesting works, you first need clarity on how capital gains are classified and taxed in India. The rules for using losses depend directly on this classification.
For equity-related investments, equity shares, equity mutual funds, ETFs, and index funds, capital gains are divided into two types based on the holding period.
Capital Gains Tax Structure for Equity (India)
| Type of Gain |
Holding Period |
Tax Rate |
| Short-Term Capital Gain (STCG) |
Less than 12 months |
20% |
| Long-Term Capital Gain (LTCG) |
More than 12 months |
12.5% on gains above ₹1.25 lakh |
A few important points to note:
- The ₹1.25 lakh exemption applies only to LTCG, not STCG
- STCG is fully taxable, regardless of the amount
- Taxes apply only when gains are realised (i.e., after selling)
This structure is what makes tax loss harvesting useful.
If you’ve booked profits, whether short-term or long-term, you may have a tax liability. But if your portfolio also contains losing positions, you can use those losses to reduce or even eliminate the tax on gains, provided you follow the set-off rules.
Before looking at examples, we now need to understand which type of loss can be set off against which type of gain. This is the most important technical part of tax loss harvesting and also where most investors get confused.
Tax Loss Harvesting in Action (Practical Scenarios)
Let’s look at how tax loss harvesting works using simple, realistic examples across equity investing and trading.
Scenario: Using LTCG Loss to Reduce LTCG Tax
Situation (Same Time Frame: Long Term Only)
You are a long-term equity investor.
Profits
Stock A (held > 1 year): ₹1,20,000 profit
Stock B (held > 1 year): ₹80,000 profit
Total LTCG profits = ₹2,00,000
Loss
Stock C (held > 1 year): ₹50,000 loss
Case 1: Without Tax Loss Harvesting
LTCG exemption = ₹1,25,000
Taxable LTCG = ₹2,00,000 − ₹1,25,000
Taxable amount = ₹75,000
LTCG tax @ 12.5% = ₹9,375
Case 2: With Tax Loss Harvesting
You book the long-term loss before year-end.
Total LTCG profits = ₹2,00,000
Less: LTCG loss = ₹50,000
Net LTCG = ₹1,50,000
Now apply exemption:
₹1,50,000 − ₹1,25,000 = ₹25,000 taxable
LTCG tax @ 12.5% = ₹3,125
Final Impact
| Scenario |
LTCG Tax |
| Without loss |
₹9,375 |
| With loss |
₹3,125 |
Tax saved = ₹5,000
By booking one long-term loss, you reduced your taxable LTCG, pushed more gains under the ₹1.25 lakh exemption, and cut your tax in half without changing your investment strategy.
Set-Off Rules Explained (STCL vs LTCL)
Tax loss harvesting works only if you understand how different types of losses can be adjusted against gains. The Income Tax Act is very specific about this.
Broadly, there are two types of capital losses:
- Short-Term Capital Loss (STCL)
- Long-Term Capital Loss (LTCL)
Each has different set-off rules.
Capital Loss Set-Off Rules (Equity & Equity-Oriented Instruments)
| Loss Type |
Can Be Set Off Against |
| STCL |
STCG and LTCG |
| LTCL |
LTCG only |
What this means in practice:
Short-Term Capital Loss (STCL)
This is the most flexible type of loss.
If you book a short-term loss:
- It can be adjusted against short-term gains
- It can also be adjusted against long-term gains
This makes STCL especially valuable for investors and traders who frequently book short-term profits.
Long-Term Capital Loss (LTCL)
This comes with a restriction.
If you book a long-term loss:
- It can be adjusted only against long-term gains
- It cannot be set off against short-term gains
This distinction is critical and often misunderstood.
What About F&O (Derivatives)?
Losses from Futures & Options are treated differently.
- F&O income is classified as business income
- F&O losses can be set off only against business income
- They cannot be adjusted against capital gains from equity or mutual funds
This means:
- Equity losses ≠ F&O losses
- Capital gains ≠ business income
Understanding this separation is essential before attempting any tax loss harvesting strategy involving derivatives.
Now that the rules are clear, let’s see how this works in real life with numbers.
Most Important Condition (Often Missed)
You must file your income tax return on time.
If you do not file your return, or if you file it after the due date, the right to carry forward losses is lost even if those losses are genuine and properly recorded.
This is a common mistake among active traders who skip filing in loss years and long-term investors who assume that “no tax payable” means no return is required.
What Tax Loss Harvesting Is NOT
Tax loss harvesting is allowed under Indian tax law but only within clearly defined boundaries.
Fake or artificial loss creation
Losses must arise from genuine market transactions. You can’t manufacture losses just for tax purposes.
Circular trading
Buying and selling the same security repeatedly to generate artificial losses can attract scrutiny.
Tax evasion or a loophole
Tax loss harvesting uses explicit set-off provisions provided in the Income Tax Act. There’s nothing hidden or gray about it.
Applicable to exempt income
Losses cannot be set off against income that is completely exempt from tax.
When Does Tax Loss Harvesting Actually Make Sense?
Tax loss harvesting is most effective when it’s used deliberately, not reactively. The timing and context matter as much as the numbers.
Here are situations where it genuinely makes sense:
Toward the End of the Financial Year
This is when most investors:
- Have clarity on realised gains
- Can estimate tax liability
- Can decide whether booking certain losses is worth it
That’s why tax loss harvesting is often called an end-of-year portfolio clean-up tool.
During Portfolio Rebalancing
If a stock, fund, or ETF no longer fits your strategy, has structurally underperformed, or needs to be exited anyway, booking the loss serves two purposes at once.
It allows a strategic exit from a weak position while also enabling tax optimisation.
After a Strategy Shift
When investors move from:
- Active trading → long-term investing
- Direct stocks → index funds / ETFs
Loss booking becomes part of a disciplined transition, not a panic decision.
For Active Traders With Volatile P&L
Traders, especially in equity and F&O, often experience profitable years followed by weak ones, along with large swings in taxable income.
Tax loss harvesting and proper carry-forward planning help smooth post-tax returns and reduce the tax shock that tends to hit during highly profitable years.
Frequently Asked Questions: Common Mistakes in Tax Loss Harvesting
Do unrealised (paper) losses help in tax loss harvesting?
No. Unrealised losses that you see in your portfolio have no tax value. For a loss to be considered for tax purposes, the asset must actually be sold. Until a sale happens, the loss remains notional and cannot be set off, carried forward, or used in any form of tax planning.
Is it useful to book losses if I don’t have gains?
Not always. Tax loss harvesting is most effective when you have taxable gains either in the same financial year or in future years where losses can be carried forward. Booking losses without a clear plan often leads to unnecessary trades and effort, with little real benefit.
Can equity losses be adjusted against F&O losses (or vice versa)?
No. Equity losses are treated as capital losses, while F&O losses are treated as business losses. Tax laws do not allow these two to be adjusted against each other. Many traders realise this only after filing returns, at which point corrections are usually not possible.
What happens if I miss the ITR filing deadline?
This is one of the most expensive mistakes you can make. If you fail to file your return on time or skip filing because you think there’s no tax payableyou permanently lose the right to carry forward losses. That benefit is gone for good.
Do transaction costs matter in tax loss harvesting?
Yes, and often more than people expect. Brokerage, STT, and other charges reduce the actual benefit of harvesting losses. In smaller portfolios, the tax saved may not even cover the cost of exiting and re-entering positions. Tax loss harvesting should improve net returns, not just look good on paper.
Should tax loss harvesting drive my investment decisions?
No. Tax loss harvesting is not a reason to exit quality businesses or justify emotional or panic selling. It works best as a supporting tool something you use alongside sound investment decisions, not as the main driver of them.
