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Crisis: Book loss to benefit
Amar Pandit in Mumbai | March 23, 2009 12:53 IST
Last April, Rajeev Sharma (name changed) sold his property for a short-term capital gain of Rs 50 lakh. Realising that his taxation will be quite high, he decided to invest some money in the dwindling stock markets.
As a result, he invested Rs 30 lakh in mutual funds in May. He sold his holdings for a mere Rs 10 lakh in October. So, he had a short-term capital loss of Rs 20 lakh. He then entered mutual funds at much lower levels. Here's how his numbers worked out.
Short-term capital gains: Rs 50 lakhs (Rs 5 million)
Tax on this gain: 33.99 per cent of Rs 50 lakhs = Rs 17 lakhs (Rs 1.7 million)
Short-term capital loss created: Rs 20 lakhs (Rs 2 million)Short-term capital gain (post loss): Rs 30 lakhs (Rs 3 million)Tax on gain: 33.99 per cent of Rs 30 lakhs = Rs 10.20 lakhs (Rs 1.02 million)
Exit cost of mutual funds: Nil New entry cost: Rs 67,500 (2.25 per cent of Rs 30 lakhs)
Now, since he has incurred a loss of Rs 20 lakhs (Rs 2 million), he can off-set that amount against the gain of Rs 50 lakhs (Rs 5 million). So, he will be taxed on only Rs 30 lakhs (Rs 3 million). That is, Sharma has saved Rs 6,80,000 in taxes.
Also, by reinvesting the money, he spent another Rs 67,500. But his net savings were Rs 6,12,000.
At the same time, he has reshuffled his portfolio to have appropriate investments, and he entered the relevant funds at a much lower cost. This lower entry cost is an icing on the cake, but you cannot expect it to happen always and must be prepared to live with a higher entry cost. This will shrink the gains slightly, but the strategy is worth it when the tax saved is substantial.
And it is important to remember that, even if there are no capital losses now, you can still benefit from exercising this strategy in the next eight years. That is, you can sell a capital asset such as property and jewellery that will result in substantial capital gains.
That brings us to short-term capital loss and the benefits of booking it. A capital loss is any loss arising from the transfer of any capital asset. Whenever a capital loss arises, you must first understand whether it is a short-term capital loss or a long-term capital loss. The principles of time apply in this case.
Remember three important things:
In fact, this is one of the strategies that you can look at if you are sitting on any short-term equity market losses. When things go wrong, you must first evaluate the situation and see if there is any way you can profit by making any course corrections.
There are two things that you must keep in mind. First, every buy and sell order requires that a brokerage must be paid. Second, you must enter quickly because if the markets move up, your entry will happen at a higher cost. On the other hand, if equity markets go down, you will have the additional benefits of a lower price.
Hence, you must do this transaction swiftly based on your outlook and your view of the market.
The writer is a certified financial lanner