This article explains the concept of tax harvesting and provides a free tool that can help you locate those mutual funds in your portfolio that can save tax by harvesting.

📚 Table of Contents

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• How to save ₹15625 by harvesting tax in mutual funds?
• Understanding Tax Harvesting in Mutual Funds
  • With 1.25 lakhs Exemption Rule
  • Without 1.25 lakhs Exemption Rule
• Eligibility Criteria for Tax Harvesting in Mutual Funds
• Step-by-Step Guide to Implementing Tax Harvesting
• Avoiding Common Mistakes in Tax Harvesting
  • Avoid wash sales
  • Do not let too much time pass between the sale and repurchase
  • Do not place the entire order to harvest the full ₹1.25 lakhs tax at once

What is tax harvesting?

Tax harvesting allows investors to strategically sell mutual fund units to take advantage of the ₹1.25 lakh exemption on long-term capital gains tax, as per Budget 2024. By selling and immediately repurchasing these units, investors can effectively increase the purchase price of their holdings, leading to significant tax savings in the future. This method ensures compliance with tax regulations while optimizing investment returns.

How to save ₹15625 by harvesting tax in mutual funds?

Budget 2024 announced in July 2024 that equity shares and mutual funds with equity-like taxation offer an opportunity for tax harvesting and saving up to ₹15625 in capital gains tax.

Tax harvesting can be applied to:

• Domestic Stocks
• Mutual Funds with equity-like taxation, including equity, some hybrid funds and index funds

Capital gains tax calculation for equity-taxed funds:

• Short-term holding period: 365 days or less, otherwise long-term
• Short-term capital gains tax rate: 20%
• Long-term capital gains tax rate: 12.5%

The rule that lets us save tax is:

No long-term capital gains tax below ₹1.25 lakhs per PAN in this category per financial year.

Therefore, if we sell off some mutual funds where the eligible long-term capital gains (LTCG) do not exceed ₹1.25 lakh in the current financial year, i.e. FY2025-26, then we can save 12.5% of 1.25 lakhs or ₹15,625 in tax in the future. We need to immediately reinvest the amount sold back into similar funds so that the benefit of compounding is not lost.

This tax saving does not happen today. Since you are selling and reinvesting, you are effectively increasing the purchase price of your holdings and you get the benefit in the future when you actually sell those units.

This plan is called “Tax Harvesting” and with the right tools will help you save ₹15625 of LTCG tax.

Understanding Tax Harvesting in Mutual Funds

If units sold in different funds are sold at a price higher than the purchase price and the total profit is:

• less than 1.25 lakhs then the tax is zero.
• more than 1.25 lakhs then tax of 12.5% (+ cess + surcharge) is payable on the amount more than 1.25 lakhs.

So if the LTCG is ₹145,000, then the tax payable is ₹20,000 * 12.5% = ₹2,500 + cess + surcharge.

This feature of the tax code gives an opportunity to book ₹125,000 profit every year in equity funds or stocks to save ₹10,000 in taxes. Note that this feature is calculated on ₹1.25 lakh of profits and not on the sale consideration.

For example:

With 1.25 lakhs Exemption Rule

Item	Price/Amount
Purchase price (A)	100
Units (B)	10,000
Book value (C=A*B)	10,00,000
Current price (D)	250
A year or more later	–
Units sold (F)	840
Market value (G=F*D)	210000
Capital gains H=(D-A)*F	126,000
Taxable capital gains = H - 1.25lakh	1,000
Tax @ 12.5% = T1	125
Units repurchased at 250 = U = G/D	840
A year or more later	–
Current price (D2)	350
All units sold F2 = B-F+U	10,000
Market value M=F2 * D2	35,00,000
Purchase amount = X = (B-F)*A + G	11,26,000
Profit = P = X-M	23,74,000
Taxable capital gains = P - 1.25lakh	22,49,000
Tax @ 12.5% = T2	281,125
Total tax = T1+T2	281,250

Without 1.25 lakhs Exemption Rule

Item	Price/Amount
Purchase price (A)	100
Units (B)	10,000
Book value (C=A*B)	10,00,000
A year or more later	–
Current price (D)	350
All units sold (B)	10,000
Market value (E=D*B)	35,00,000
Capital gains (F=E-C)	25,00,000
Taxable capital gains G=F-1.25 lakh	23,75,000
Tax @ 12.5% = G * 12.5%	296,875
Tax with harvesting	281,250
Tax saved due to harvesting	15,625

This example shows that harvesting 840 units after year 1 saved ₹15,625 tax. While using this method, the investor has to be mindful of the concept of the wash sale rule. It is better to combine LTCG harvesting along with portfolio rebalancing so that the sale proceeds are invested in different funds. You can do this either in March or throughout the year. The exemption is for total sales over the year.

Eligibility Criteria for Tax Harvesting in Mutual Funds

All funds that have equity taxation can be used to do this tax-harvesting.

• Equity Mutual Funds with 65% or more domestic stocks (or arbitrage positions in domestic stocks)
• Hybrid Mutual Funds with 65% or more domestic stocks (or arbitrage positions in domestic stocks) like arbitrage, equity savings or aggressive hybrid
• Fund of Funds holding 90% or more in domestic ETFs

Find out which fund categories which can be used for tax harvesting

Step-by-Step Guide to Implementing Tax Harvesting

To do tax harvesting, you need to follow these steps:

• Step 1: identify which funds in your portfolio can be sold to perform tax harvesting
• Step 2: sell those units and get the money. Ensure that the profit from that sale, including all other equity-like LTCG in the current financial year FY2025-26 does not exceed ₹1.25 lakhs
• Step 3: repurchase the same amount that you get from the sale into other funds

Note: Mutual funds follow the First-in-first-out (FIFO) rule for calculating which units will be taxed when you sell them.

How does FIFO rule work?

Finding the right funds and the correct number of units can be a tricky exercise:

• you need to find those funds which are eligible for equity taxation
• then you need to calculate the LTCG-eligible units, that are not yet sold, using the FIFO rule

However, both of the above steps can be done easily as a part of the Arthgyaan Free Mutual Fund Review Service that includes a table for funds with harvest-eligible units.

Start your free mutual fund review

Avoiding Common Mistakes in Tax Harvesting

There are a few rules that you should follow when doing tax harvesting:

Avoid wash sales

To perform tax harvesting, you need to sell something and then immediately buy it. The wash sale rule says that you cannot buy the same or very similar security within a short span of selling it. Tax authorities frown upon this practice in general.

India does not have a wash sale rule today. However, from an optics perspective, it will be better for investors to avoid performing a wash sale as much as possible.

Do not let too much time pass between the sale and repurchase

If there is a sharp upward movement in the market when you have sold the fund units and are waiting for the cash to hit your bank account, then you can lose out on the benefits since your repurchase level will be higher than the current level.

To solve this problem, whenever you sell units for the purpose of tax-harvesting, ensure you place a buy order for the same amount 1-2 days before. Placing the buy order early ensures that your NAV allocation date is as close as possible to the selling date.

Do not place the entire order to harvest the full ₹1.25 lakhs tax at once

You can do this as a series of sell-and-buy transactions until you have used up the entire limit. This allows you to stagger the trades as per market movements and let’s to sell only those funds that should be sold at that time.