Turning Tax Understanding into Smarter Choices (Equity)

This article is a part of our Have You Factored Taxes in your Returns? series. In Part I of the series, we gained a basic understanding of the tax laws around equity investing. In this part, we look at some practical applications of turning that understanding into smarter investment decisions.

Tax Loss Harvesting

A temporary dip in portfolio value can be an opportunity. Tax-loss harvesting involves selling investments currently at a loss to offset capital gains from other holdings (or to carry forward the losses for future set-offs). This helps reduce overall taxable capital gains for the year, while allowing you to reinvest in similar/same assets to stay aligned with investment goals.

Tax Gain Harvesting

Tax-gain harvesting is the reverse - it means realising long-term capital gains deliberately. The Income Tax Act provides a tax exemption on long term capital gain of up to ₹1.25 lakh in a financial year, provided the gain is from listed equity shares or equity-oriented mutual funds (“equity instruments”). Thus, an investor can sell equity instruments and book gains of up to ₹1.25 lakh in a financial year without any tax implications. This also resets the purchase cost for future gains, helping manage future tax liability.

Let us understand this with an example.

Assume you purchased 4,000 shares of X Ltd at ₹100 on 5 May 2023.

The price of these shares as on 9 February 2026 is ₹125 and it increases to ₹140 as on 8 March 2027.

We look at tax liability under 2 scenarios - with and without tax gain harvesting.

	Tax Gain Harvesting	Without Tax Gain Harvesting
Long Term Capital Gain (LTCG) in FY 2026*	₹ 1,00,000 [4,000 * (125-100)]	Nil
Tax Payable on LTCG in FY 2026	Nil**	Nil
LTCG in FY 2027	₹ 56,000 [4,000 * (140-125)]	₹ 1,60,000 [4,000 * (140-100)]
Tax Payable on LTCG in FY 2027	Nil**	₹4,375 [12.5% * (1,60,000 - 1,25,000)
Total Tax Payable on LTCG (FY 2026 + FY 2027)	Nil	₹4,375

The tax payable is excluding any surcharge and cess, assumes that the investor is able to buy back the shares next day with minimal movement in prices.

*For tax gain harvesting, the investor will sell his holdings on 9 February 2026 and buy it back on 10 February 2026.

**No tax payable since LTCG upto ₹1,25,000 is exempt in each financial year.

Some Nuances

• If an investor’s total income (from all sources combined) is close to the threshold for surcharge, they need to be careful while harvesting gains. While the gains themselves are tax exempt, they are added to the total income for determining the applicability of surcharge – so even though the gains are exempt, harvesting could cause investor’s other income to incur additional surcharge.

• An investor needs to carefully consider the exit load on mutual funds while harvesting gains/losses.

Tax Gain Harvesting can also be used for rebalancing an investor’s portfolio in a tax-efficient manner.

Growth vs. IDCW

While the decision of payout option (Growth vs. IDCW) in mutual funds is primarily guided by the investor’s need for regular income (or lack thereof), tax implications also matter in decision-making.

When a distribution is made under IDCW, 2 things happen – (i) A tax liability arises on the distribution, as discussed earlier; (ii) the NAV reduces to the extent of the distribution, implying lower capital gains in the future (when the investor redeems his units). In essence, choosing IDCW prepones the tax liability – from the time of redemption to the time of distribution.

Further, there could be a difference in the tax rate as well. Taking equity-oriented mutual funds as an example, IDCW distributions are taxed at the investor’s slab rate, whereas tax rate at redemption is 20% (short-term) or 12.5% (long term). Apart from the timing of taxation, the investor’s tax bracket can influence which option is more efficient. If the investor’s tax slab is lower than the 20% or 12.5%, IDCW option may result in lower taxes than growth, and vice versa if the investor’s tax slab is higher.

Exemption for Purchase of a House

Section 54F of the Income Tax Act, 1961 (Section 86 of the Income Tax Act, 2025) grants an exemption from tax on long term capital gains, if the proceeds are used to purchase a residential house. Thus, if you sell your equity shares or mutual funds (classified as 'long term' based on criteria discussed in the Part 1 of this series) to purchase a house, the gain on sale of mutual funds may be exempt.

The exemption is available only to individuals and HUFs, and involves multiple conditions, which are based on the following:

• Number of houses owned by the individual

• Timing of purchase or construction of the house

• Restriction on additional houses that can be purchased or constructed within the next 1 and 3 years respectively

• Pro-rata exemption if the entire sales proceeds are not utilized for purchase/construction of the house

• Restriction on sale of the purchased house for 3 years

• Restriction on the purchase price of house (Rs. 10 crores), beyond which deduction would be restricted

Please note that we have not listed down all the conditions around the exemption. Further, each of these conditions are very nuanced and have specific rules/guidelines surrounding them - so please consult your tax advisor before decision making.

Thus, if you are allocating a part of your equity investments or SIP towards your long-term goal of purchasing a house, you can avail this exemption and retain most of your underlying returns.

This also ties-back to the concept of tax-gain harvesting - since the funds earmarked for purchase of house would anyway be exempt at the time of redemption, an investor can focus/prioritise gain harvesting on the portion not earmarked for purchase of a house.

Using National Pension Scheme (NPS)

For a salaried person, contributions by employer to NPS, up to 14% of salary (Basic Salary + Dearness Allowance) in new tax regime and 10% in old tax regime, are available as deduction from taxable income – thereby reducing the tax paid by the investor in his/her earning period. This presents a good opportunity to gain exposure to equity and save taxes at the same time. However, money invested in NPS is subject to a lock-in until investor reaches 60 years of age, and even after that, 60% of corpus can be withdrawn tax-free while the remaining 40% has to be used to purchase annuities.

Despite the lock-in, NPS can be a good option for funds allocated towards building an investor’s retirement corpus. We cover the taxation of NPS in detail here.

We also cover smart tax choices in debt and other investments in Taxation of Debt Investments.

Disclaimer

Assumptions used in the analysis:

• The tax provisions mentioned above are based on the prevailing law as of February 2026 for resident Indian individuals

• Assumes the investments will be sold after 1 April 2025

• Our analysis assumes equity shares and mutual funds are not treated as stock-in-trade or trading business of the investors. Further, Intraday gains are charged separately as speculative income, F&O as business income and our analysis does not cover these

• Advance tax is payable in the quarters in which capital gains are realized based on applicable rules

• Tax provisions are open to interpretation so please consult your tax advisor before any decision making

Disclaimer:

The information provided in this discussion is strictly for educational and informational purposes and does not constitute professional financial, investment, legal, or tax advice. Mutual fund investments are subject to market risks, including the potential loss of principal, and past performance is not a reliable indicator of future results. All specific fund names, historical events, or financial metrics mentioned are for illustrative purposes only and should not be construed as recommendations to buy or sell any security. You are strongly advised to consult with a Mutual Fund Distributor or a SEBI-registered investment advisor or a qualified financial planner to assess your specific risk profile, tax bracket, and financial goals before making any investment decisions.