As the financial year draws to a close, many investors start reviewing their portfolios to see if they can reduce their tax outgo. One strategy that often comes up during this period is tax harvesting—booking capital gains up to the tax-free limit or realizing losses to offset gains and lower the overall tax bill.
The strategy can improve tax efficiency, but advisors warn it should not become an automatic year-end ritual. When used mechanically, tax harvesting can lead investors into unnecessary trades, poor portfolio choices and behavioural mistakes that hurt long-term returns.
“Tax loss harvesting can be useful, but the investor has to be cognisant of certain behavioural pitfalls. As long as it remains an add-on activity and doesn’t dictate your overall portfolio construction, it is fine,” said Ravi Saraogi, founder, Samasthiti Advisors.
Tax laws allow investors to realize long-term capital gains on equities and equity (MFs) up to ₹1.25 lakh in a financial year without paying tax. Capital losses can also be used to offset gains and reduce tax liability. However, advisors say investment decisions should be driven primarily by portfolio strategy rather than tax calculations alone.
“Tax harvesting should be a byproduct of portfolio decisions, and not vice versa,” said Vinit Iyer, principal officer at Prudeno Wealth, an investment advisory firm.
“Say, you want to stop investing in a fund as part of portfolio rebalancing, and replace it with a new fund. In this case tax harvesting can be used strategically when you redeem from the first fund and reinvest into the replacement fund in your portfolio.”
When harvesting backfires
Tax harvesting can become counterproductive when investors rush to book gains simply to use the annual exemption limit. While realizing gains up to ₹1.25 lakh tax-free may look attractive, it often requires selling a large portion of the investment.
Consider this example. Suppose an investor bought 10,000 units of an equity MF two years ago at a net-asset value (NAV) of ₹150, investing ₹15 lakh. The current NAV is ₹170, taking the portfolio value to ₹17 lakh. The gain per unit is ₹20.
If the investor wants to realize gains of ₹1.25 lakh, they will need to redeem 6,250 units (units to redeem = target gain ÷ gain per unit). Redeeming 6,250 units at the current NAV of ₹170 would mean withdrawing about ₹10.6 lakh—even though the investor is only booking a ₹1.25 lakh gain.
This means a large portion of the portfolio temporarily moves out of the market.
The next challenge is reinvestment. Investors often delay putting the money back or try to time the market, said Iyer.
“I have seen situations where investors complete a harvesting transaction but then end up using the proceeds for unrelated expenses or alternative investments. They move the money temporarily into cash, arbitrage funds or even a completely different asset class such as gold or silver.”
Behavioural traps
Such decisions can break the compounding cycle of the original investment.
For instance, suppose you book ₹1.25 lakh of gains from an equity MF to use the tax-free exemption limit and instead reinvest the money in gold after its recent rally.
Over the next 10 years, assume the equity MF delivers a 12% CAGR while gold delivers 10%. At 12%, ₹1.25 lakh would grow to about ₹3.88 lakh in 10 years, while at 10% it would grow to about ₹3.24 lakh. The difference of roughly ₹64,000 represents the loss in compounding from switching assets based on recent returns.
By comparison, the tax saved from harvesting the ₹1.25 lakh gain would only be about ₹15,625.
This behavioural shift is one of the biggest risks of tax harvesting and is even more relevant this year, said Saraogi.
“Investors are already jittery with the correction in the stock market amidst the ongoing war and the moment they take the money out, all kinds of fears may start creeping in. They will start thinking about geopolitical events or market corrections and then try to forecast the market,” he said.
Iyer concurred. If the money doesn’t come back into the portfolio, the entire exercise defeats the purpose.
Tax distortions
Another common mistake occurs when investors allow tax considerations to dictate investment decisions.
Saraogi noted that investors sometimes hesitate to book losses if they do not have gains elsewhere to offset them against.
“Let’s say you are holding a bad stock or a poorly performing MF and you know you should exit. But if you approach it from a tax loss harvesting point of view, you may not book that loss unless you have a capital gain to offset it,” he said.
This can create a perverse incentive. An investor who should exit a losing position may continue holding it simply to preserve the possibility of using that loss later. If the investment continues to underperform, the eventual loss may become larger.
A better approach is to book the loss even if there is no immediate tax benefit and carry forward the losses—allowed up to eight subsequent years under both .
Many investors hesitate to take such a long-term view because tax rules change frequently.
“This uncertainty often pushes investors toward short-term tax optimisation rather than better portfolio management,” said Saraogi.
Surcharge surprise
Risks can also increase when harvesting short-term losses.
For example, if you book short-term losses and reinvest but exit the position within six months after it turns profitable, the gains will be taxed at the higher 20% short-term capital gains rate because the holding period resets from the date of reinvestment. Additionally, most (AMCs) charge an exit load for selling within a year.
Tax loss harvesting can also backfire for those with incomes just below the ₹50 lakh surcharge threshold.
Suppose your income is ₹48 lakh and you book ₹4 lakh in long-term capital gains to offset losses on another asset. Even though you won’t pay long term capital gains (LTCG) tax after offsetting, your net income rises to ₹52 lakh, pushing you into the surcharge bracket.
In saving about ₹47,000 in LTCG tax, you could end up paying an additional ₹1.84 lakh in income tax.
Using it wisely
When used within a broader investment strategy, tax harvesting can still help reduce tax outgo.
Given market drawdowns over the last 18 months, many investors may be sitting on losses. If they have booked gains elsewhere, they can use those losses to reduce their tax liability. Short-term losses can be offset against both long-term and short-term gains.
Iyer noted that loss harvesting should only be done for MFs or stocks that investors intend to hold for at least another year.
Loss harvesting may also be relevant this year for investors holding Sovereign Gold Bonds (SGBs) bought in the secondary market. Starting 1 April, gains on such SGBs will be taxed at 12.5% even if held till maturity. Investors could therefore consider booking profits before the year end and offsetting them with losses on MFs or stocks.
Investors should also keep cut-off times and settlement cycles in mind. Redemption requests placed too late could push the transaction into the next financial year and nullify the intended tax benefit.
Overall, advisors say investors should evaluate whether the potential tax savings justify the complexity.
“Every activity has to be looked at in conjunction with the mental bandwidth it consumes. There is a lot of research showing that people who try to over-optimise their portfolios often end up doing worse. If the tax saving is a few thousands, investors should avoid the hassle,” said Saraogi.