Tax Harvesting in India: Cut Capital Gains Tax on Stocks and Mutual Funds (FY 2025-26)

When investments fall in value, the instinct is to hold and wait. But selling a loss-making position before the financial year ends has a concrete tax benefit: that loss can reduce the tax payable on gains elsewhere in the portfolio. This is tax harvesting, or tax-loss harvesting.

It is not a loophole. It follows directly from how the Income Tax Act treats capital loss set-off and carry-forward. This guide covers how it works for both stocks and mutual funds, the rules that apply in FY 2025-26, and the situations where harvesting makes sense and where it does not.

What Is Tax Harvesting? (And What It Is Not)

Tax harvesting is an umbrella term for two related strategies that use the capital gains framework of the Income Tax Act to manage tax liability.

Tax-loss harvesting means selling an investment that is currently below its purchase price, realising a capital loss. That loss can then be set off against capital gains realised elsewhere in the same financial year, reducing the net taxable gain. If losses exceed gains, the surplus can be carried forward for up to 8 assessment years.

Tax-gain harvesting (sometimes called tax-gain booking) means the opposite: selling a profitable long-term holding within the annual ₹1.25 lakh LTCG exemption threshold, paying zero tax on that gain, and reinvesting. This resets the cost of acquisition higher, reducing the taxable gain when the position is eventually sold for good.

Capital Gains Tax Rates: FY 2025-26

The July 2024 Budget revised both the rates and the LTCG exemption threshold. The pre-2024 figures (STCG 15%, LTCG 10%, exemption ₹1 lakh) no longer apply. These are the current rates for transfers on or after July 23, 2024.

All rates are base rates before surcharge and 4% cess. The ₹1.25 lakh exemption applies only to equity LTCG under Section 112A. Debt-oriented MF gains are taxed at the investor's applicable income tax slab rate, which means the tax saved per rupee of debt fund loss depends on the investor's slab, not a fixed rate.

Set-Off Rules: What Losses Can Offset What

The Income Tax Act specifies exactly which losses can be used against which gains. The rules are not symmetric, and getting them wrong is one of the most common errors in ITR filing.

Carry-Forward Rules

If capital losses are not fully absorbed in the year they arise, the unabsorbed amount carries forward to future years.

• Both STCL and LTCL can be carried forward for up to 8 assessment years from the assessment year in which the loss was first computed.
• When carried forward, the same set-off rules apply: STCL can offset STCG or LTCG; LTCL can only offset LTCG.
• The ITR must be filed by the due date under Section 139(1) (typically July 31 for non-audit cases) for the year in which the loss arises. Filing late permanently forfeits the carry-forward benefit for that year's losses.
• In practice, brought-forward losses from earlier years are adjusted through the BFLA (Brought Forward Loss Adjustment) computation before the ₹1.25 lakh Section 112A exemption is applied to any remaining LTCG. Confirm the sequencing with a Chartered Accountant when filing.

Tax Harvesting for Mutual Fund and SIP Investors

How Mutual Fund Losses Work

Mutual fund capital losses follow the same STCL and LTCL rules as direct equity. An equity MF held for 12 months or less generates STCL on sale at a loss; held for more than 12 months, it generates LTCL. Cross-asset set-off is permitted: a mutual fund loss can offset a stock gain, and a stock loss can offset a mutual fund gain, provided the STCL/LTCL classification is respected.

A switch instruction, even within the same AMC, counts as a full redemption followed by a fresh purchase for tax purposes. The gain or loss is crystallised in the year of the switch, not when the new units are eventually sold.

Equity funds held under one year typically carry a 1% exit load. This cost directly reduces the net tax saving. Factor it into the calculation before deciding whether selling is worthwhile.

A Note for SIP Investors

Each SIP instalment is a separate acquisition lot with its own date, NAV, and holding period. The overall fund value can be positive while units purchased at elevated NAVs are sitting in loss. This creates harvesting opportunities even in broadly rising markets, particularly for SIP portfolios that have been running for two or more years.

Redemptions follow FIFO: the oldest units are always sold first. Within a single folio, there is no mechanism to skip older units and redeem only recent ones. This matters because older units in a long-running SIP tend to be in profit. A standard redemption from such a folio will typically crystallise a gain, not a loss.

The practical check: before any redemption, pull the lot-wise capital gains report from the broker or AMC (Zerodha Console, Groww P&L, or a CAMS/KFintech statement). This shows exactly which units FIFO will sell first and whether they are in profit or loss. Where the FIFO units are in loss, harvesting is straightforward. Where they are in profit, a partial redemption or a folio-specific approach may be needed, and a Chartered Accountant's guidance is worth seeking.

Examples: Stocks, Mutual Funds and Tax-Gain Harvesting

Example 1: STCL from Stock Offsets STCG from Another Stock

Example 2: MF Investor with LTCL, ₹1.25L Exemption Sequencing

A salaried investor in FY 2025-26 has the following capital gains position before harvesting:

Note: Brought-forward losses from prior years (if any) would be set off before the ₹1.25 lakh exemption is applied. Confirm the exact sequencing with a Chartered Accountant.

Example 3: Tax-Gain Harvesting (Booking ₹1.25L LTCG Tax-Free)

This strategy is most effective when done annually and consistently. The ₹1.25 lakh exemption resets every financial year and cannot be carried forward if unused.

Tax-Gain Harvesting: Using the ₹1.25 Lakh LTCG Exemption

For long-term equity investors, the annual ₹1.25 lakh LTCG exemption under Section 112A is a recurring planning tool. Selling profitable holdings up to this threshold each year, paying zero tax, and immediately reinvesting resets the cost of acquisition without any tax outgo. Over multiple years this progressively reduces the taxable embedded gain in the portfolio.

The exemption applies per financial year and cannot be accumulated or carried forward. An investor who does not use it in a year simply loses that year's benefit.

When Tax Harvesting Makes Sense (and When to Skip)

Tax harvesting is a mathematical exercise, not a ritual. The decision should be driven by actual numbers, not calendar proximity to March 31.

The basic calculation: estimated tax saving = loss to be harvested multiplied by the applicable rate (20% for STCG, 12.5% for LTCG, or slab rate for debt MFs). From this, subtract all transaction costs: brokerage, STT, GST on brokerage, and any exit load. If the net figure is positive and meaningful relative to the effort, harvesting makes sense.

The worst approach is harvesting automatically every March without checking whether you have taxable gains to offset, whether the loss type matches the gain type, or whether selling will convert future LTCG into STCG.

How to Do Tax Harvesting: Step by Step

1. Pull your capital gains report. Most brokers (Zerodha Console, Groww P&L, Upstox tax report) and AMC portals generate a lot-wise unrealised gain and loss breakdown. This shows exactly which positions are in loss, whether they are short-term or long-term, and by how much.
2. Separate STCL and LTCL candidates. Short-term losses are more flexible. They can offset both STCG and LTCG. Long-term losses can only offset LTCG. Prioritising STCL candidates makes sense if you have a mix of STCG and LTCG to cover.
3. Calculate the net benefit for each position. Tax saving = loss amount multiplied by applicable rate. Subtract brokerage, STT, and exit load (for MFs held under 1 year). Only proceed if the net figure is clearly positive.
4. Execute before the financial year end, with settlement buffer. Equity settlements follow T+1 (trade date plus one business day). The effective last trading day to ensure settlement within the financial year falls before March 31. The exact date depends on the year's calendar and exchange holidays. Verify the NSE/BSE settlement schedule before executing year-end trades.
5. Reinvest in a similar but different instrument. Sell Fund A (large-cap) and reinvest in Fund B (different large-cap from another AMC) to maintain market exposure. Note that India has no formal wash-sale rule (unlike the US), so repurchasing the same security is not legally prohibited. However, if the same security is repurchased, the holding period restarts from the new date, which affects future STCG or LTCG classification.
6. File the ITR on time. To carry forward any unadjusted losses, the ITR must be filed by the due date under Section 139(1), typically July 31 for non-audit cases. Late filing permanently forfeits that year's carry-forward.

FAQs

1. What is tax harvesting in simple terms?

Tax harvesting means using realised capital losses to reduce the tax you pay on capital gains in the same financial year. If you have made profits on some investments and losses on others, you can sell the loss-making ones before March 31 to offset the gains and pay tax on the net amount rather than the gross profit. The term also covers tax-gain harvesting, where you book profitable long-term gains within the annual ₹1.25 lakh LTCG exemption to reset your cost base tax-free.

2. Can I offset a mutual fund loss against stock gains?

Yes. Capital losses and capital gains fall under the same income head regardless of whether the instrument is a stock or a mutual fund. A mutual fund STCL can offset stock STCG or LTCG. A mutual fund LTCL can offset stock LTCG. The STCL/LTCL rules apply to the loss, not to the instrument type.

3. Does tax harvesting work differently for mutual funds vs stocks?

The set-off rules are the same. The practical differences are in execution. Mutual fund redemptions follow FIFO, which means a blanket redemption often crystallises gains from older units rather than losses from recent ones. For SIP portfolios, a targeted redemption of only the loss-making lots is needed. Mutual funds also carry exit loads (typically 1% for equity funds held under a year) which reduce the net benefit. Switches between schemes are treated as redemptions for tax purposes even within the same AMC.

4. Can SIP investors do tax harvesting?

Yes, and SIP portfolios often have more harvesting opportunities than lump-sum investments. Each SIP instalment is a separate acquisition lot with its own date and NAV. Units purchased at higher NAVs during market peaks may be in loss even if the overall fund has gained. Reviewing the lot-wise breakdown on the broker or AMC portal before redeeming allows a SIP investor to identify and redeem only the loss-making tranches while leaving the profitable lots intact.

5. Can a long-term capital loss offset a short-term capital gain?

No, not under the current Income Tax Act 1961 for FY 2025-26. Long-term capital losses can only be set off against long-term capital gains. They cannot reduce short-term gains. The final enacted Income Tax Act 2025 preserves this same restriction for brought-forward losses through its savings clause, which requires adherence to the old-Act set-off rules.

6. How many years can capital losses be carried forward?

Both STCL and LTCL can be carried forward for up to 8 assessment years from the assessment year in which the loss was first computed. The condition is that the ITR for the loss year must be filed by the due date under Section 139(1). A late return forfeits carry-forward for that year's losses permanently.

7. What is the LTCG exemption for equity in FY 2025-26?

The annual exemption under Section 112A for LTCG from listed equity shares, equity-oriented mutual funds, and business trust units is ₹1.25 lakh per financial year. Gains up to this amount in a year are tax-free. This was revised upward from ₹1 lakh effective July 23, 2024 and applies only to LTCG under Section 112A, not to STCG or to LTCG on other assets.

8. Can capital losses reduce salary or business income?

No. Capital losses, whether short-term or long-term, can only be set off against capital gains. They cannot reduce salary, business income, rental income, or income from other sources. F&O losses are treated differently: they are classified as non-speculative business losses and can be set off against most income heads except salary within the same financial year.

9. Is tax harvesting legal in India?

Yes. Tax harvesting follows directly from the set-off and carry-forward provisions of the Income Tax Act, 1961. It is a recognised and legal approach to managing capital gains tax liability. The tax department has not challenged ordinary tax-loss harvesting by individual investors. The relevant caution is GAAR (General Anti-Avoidance Rules), which applies to artificial arrangements with no genuine economic substance. This is not triggered by standard year-end harvesting of genuine portfolio losses.

Disclaimer: This article is for general information and educational purposes only. It does not constitute investment advice, tax advice, or a recommendation to buy, sell, or hold any security or fund. Capital gains tax rates, set-off rules, and carry-forward provisions described here are based on the Income Tax Act, 1961 as amended, applicable for FY 2025-26 (AY 2026-27). The final enacted Income Tax Act 2025 preserves the Section 74 set-off restrictions for brought-forward losses; the broader transitional relief proposed in the draft Bill did not become law. Tax rules may change in subsequent budgets or notifications. Please consult a qualified Chartered Accountant or SEBI-registered investment adviser before making any tax-related or investment decision.