Booked Profits in Equity Mutual Funds? Here's How Tax Loss Harvesting Can Help Reduce Tax

The year 2025 was rather tough for Indian equities, marked by volatility. A variety of factors were behind it: Trump 2.0 protectionist policies, tariff tantrums, trade war, geopolitical tensions, weak Indian rupee, and more. 2025 was a year of consolidation after stupendous returns clocked in the previous couple of years. Not all equity mutual funds managed to deliver positive returns. The small-cap funds in 2025, on average, lost nearly 6%, while the mid-cap funds' returns slowed to 11.5%, on average (after a remarkable performance in the previous two years). The large-cap funds clocked a modest 9.0% on average. Whereas the flexi-cap funds, which hold a mandate to invest dynamically across the market cap segments, in 2025, reported a return of 12.5%, on average, after superior returns in the preceding two years. That said, if you have been investing for over three years in equity mutual funds, there are chances that you've made decent gains. If you have booked profits in FY26 or are planning to, there are implications. But say you made a notional loss, perhaps its make sense to book a loss (particularly if the fund isn't performing well). Here's why... This could facilitate you to do tax loss harvesting. What is Tax Loss Harvesting? Well, you essentially book capital losses on some that are not so worthy and have left you disappointed. This indirectly may help reduce your capital gain tax liability. Thus, tax loss harvesting is also known as capital loss harvesting. So, how does it work? Against the capital gains on some investments (that have built wealth over a long time), the capital loss is adjusted. The capital loss could be short-term or long-term, depending on the holding period of your investment. If the holding period in case of equity-oriented funds is 12 months or less, it is treated as Short-Term Capital Loss, whereas if it's more than 12 months, it is considered Long-Term Capital Loss. This period also applies when defining Short-Term Capital Gain and Long-Term Capital Gain. The Income Tax Act, 1961, allows for set-off and carry-forward of capital losses against capital gains. A capital loss cannot be set off against any other head of income. Set Off Capital Loss The current rules allow for setting off your STCL against both STCG and LTCG. However, an LTCL can be set off only against an LTCG. Moreover, LTCG applies only if such gains are over Rs 1.25 lakh in a financial year. So, essentially, with set-off availed, you pay tax only on the net capital gains. Let's understand this with a case study. Say Sanjay has booked STCG and LTCG gains of Rs 50,000 and Rs 3 lakh in equity mutual funds in a financial year. In one penny stock, which he invested in on a tip from a friend, he is incurring a STCL of Rs 40,000 and is worried about it. Now here are the tax implications: If Sanjay does not indulge in tax loss harvesting (also known as capital loss harvesting), he ends up with a capital gain tax liability of Rs 31,875. Before Tax Loss Harvesting After Tax Loss Harvesting Reduction in Tax Liability after Loss Harvesting (in Rs): 8,000 However, worried about the loss in the penny stock, if he books a Short Term Capital Loss, his total capital gain tax liability reduces to Rs 23,875. That's a reduction of Rs 8,000 on account of tax loss harvesting. Now you ask: what if there is a net capital loss even after setting off? Well, in such a case, as per the extant rules, you are allowed to carry forward the capital loss. Carry Forward of Capital Loss In case you are not able to set off the capital loss completely, the Income Tax Act, 1961, allows you to carry forward the capital loss. The net capital loss can be carried forward for a period of up to 8 assessment years (relevant to the respective Financial Year) for both STCL and LTCL. But you need to be mindful to file your Income Tax Returns (ITR) on time before the due date. Otherwise, the tax department may disallow this benefit. The Other Benefits of Tax Loss Harvesting Apart from enabling you to reduce your tax liability, tax loss harvesting also helps in cleaning up your portfolio. Meaning, you can do away with the duds or underperforming investments, trim down the portfolio and ensure you hold only the worthy ones. It frees cash, which effectively could be parked in other asset classes with a favourable outlook. So, as a result, you are diversifying the portfolio indirectly while not overlooking the asset allocation best suited for you. So, with tax loss harvesting, you are also reviewing and rebalancing the portfolio. In other words, tax loss harvesting could prove strategic for your investment portfolio and legitimately help save tax. Remember, a penny saved from tax is a penny earned. To make the best use of tax loss harvesting, source your capital gain account statement for your mutual fund investments from CAMs, KFintech, or MF Central. And for stocks, from your broker and scrutinise it closely in the interest of your financial wellbeing. Happy tax planning and investing! Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article. ALSO READ: Why You Need to Review Your Mutual Fund Portfolio in 2026