How to make use of stock market losses to cut taxes
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How to make Use of stock market losses to cut taxes
Here's how it works.
You sell the stocks in your portfolio to book losses and then buy back the same stocks the next day. Any loss you make on stocks or equity funds bought less than 12 months ago can be adjusted against gains from certain other investments, including short-term capital gains from stocks and equity funds as well as long-term gains from debt funds and gold ETFs and jewellery. What's more, the unadjusted losses can be carried forward for up to eight financial years.
This doesn't mean that investors should rush out and dump all their loss-making stocks only to book tax losses. Before you embark on this tax-cutting strategy, make sure you have your investment dates right. Check when you bought the stocks that are now trading at a loss.
Only short-term capital losses from stocks can be adjusted against other gains or carried forward. The stocks you bought more than a year ago will not be eligible.
Also remember that the sale of stocks and funds is on a first-in-first-out basis. This means the shares you bought first will be deemed to have been sold first.
Suppose you bought 500 shares of a company at Rs 150 each in January 2011 and then another 500 at Rs 180 in July 2011. If you sell 500 of those shares at Rs 140 now, you will not be allowed to carry forward the loss because your holding period of the intial tranche of 500 shares has exceeded one year. It is now a long-term capital loss. Since there is no tax on long-term capital gains from stocks, there is also no provision to carry forward the long-term capital losses from this asset class.
The risks involved
Selling at a loss involves a risk. What if the stock price shoots up after you have sold? If your intention was to hold the stocks for the long term, you might have to shell out a higher price the next day. To avoid this risk, you can buy more of the stock and then sell them the next day. Under the first-in-first-out rule, it will be deemed that you have sold the shares you bought earlier.
But this strategy is also risky. If the share price falls further the next day, your losses will amplify. Some investors may want to take the upside risk and sell before they buy back the shares. Others may be more comfortable with the downside risk that entails buying more before they sell.
One way to avoid such a risk is to buy and sell your holdings in small quantities. If you have 1,000 shares of a stock in which you want to book losses, spread out your buying and selling in tranches of 100 shares over a period of 10-12 days. Sell 100 one day, then buy them back the next day. Repeat this till you have sold and bought back the entire lot. This way, you can contain the upside and downside risk to just 100-200 shares.
Taking delivery is important
When you go about selling and buying back, take care not to conduct both transactions on the same day. When you do that, you don't actually take delivery of the stocks. Such intra-day transactions are treated as speculative by the taxman and can be disputed by the tax department if you want to book losses.
In some countries, such as the US, if a taxpayer wants to book losses, there should be a 30-day gap between the sale and subsequent purchase of shares. Though there is no such rule in India, it is best to wait for a day or two before you buy back the shares so that the shares bought previously are out of your demat account before the new shares come in.
Keep the contract notes of the transactions handy. You may need to mention the details of the transactions in the tax form when you file your income tax returns.
File returns by due date -Important
The most important thing is that you can carry forward short-term losses only if you file your income tax return by the due date. Though you can safely file your return by the end of the assessment year without fear of penalty, you will not be allowed to carry forward the losses. That's one more reason to file before 31 July of every year.