Use capital losses smartly!

You can reduce your tax liability with some planning. Profits you make when you redeem your mutual fund investments are taxable in some cases. Let’s find out how to reduce your taxes payable on these profits.

Under the tax laws, capital gains or losses can be long term or short term depending on how long you stay invested. In case of debt funds, if you hold your investment for less than 3 years, the gains are short term capital gains. If you hold your investment for more than 3 years, your gains are long term capital gains.

In case of equity funds, if you hold your investment for less than 12 months, the gains are short term capital gains. If you hold your investment for longer than 12 months, then the gains are long term capital gains. A balanced or hybrid fund is treated as an equity fund if equity forms at least 65% of its portfolio. If the equity component is less than 65%, it is treated as a debt fund.

*Indexation increases your investment cost to adjust for inflation. This, in turn, reduces the taxable capital gains. In other words, it reduces the tax payable

Understanding the concept of capital losses

Before moving to the section on capital loss tax and capital loss deduction, let us understand the meaning of the term capital losses. The term refers to the financial loss you incur when the sale price of your investment or asset is lower than its original purchase price. Capital losses occur when the value of the investment declines over time and is visible in investments across asset categories like stocks, bonds, mutual funds, real estate, and other financial instruments.

When an investor sells an asset for less than its purchase price, the difference between the purchase price and the sale price represents the capital loss. Given that it is dependent upon the sale, this loss is realised only when the investment is sold and you can use it to benefit from capital loss tax norms. This loss can occur due to various factors, including changes in market conditions, economic downturns, company-specific issues, or unfavourable events affecting the industry or sector in which you have invested. These factors can lead to a decrease in demand or investor sentiment, resulting in a decline in the investment's market value and thereby leading to you facing a loss on your invested capital.