Gain harvesting: using the ₹1.25 lakh exemption every year

An allowance that lapses every 31 March

Long-term gains on equity funds and listed shares are taxed at 12.5%, but only above ₹1.25 lakh a year. That first ₹1.25 lakh is tax-free, and it does not carry forward. Skip a year and that year's allowance is gone.

Gain harvesting uses it on purpose. In a year when you have long-term gains sitting in a fund but have not sold, you redeem enough units to realise about ₹1.25 lakh of gain, then buy the same fund back. You own the same thing. The units now carry a higher cost, so the gain you are eventually taxed on is ₹1.25 lakh smaller.

Our guide to tax-loss harvesting and the post on cutting capital gains tax with losses mention this "mirror move" in a paragraph. This post runs it over ten years and prices the frictions.

A ten-year worked example

Assumptions, not forecasts: ₹10 lakh goes into a Nifty 50 index fund with no exit load, such as the UTI Nifty 50 Index Fund (Direct, Growth). The NAV grows a steady 12% a year. Once a year, a few days later than the year before, the investor sells enough units to book up to ₹1.25 lakh of long-term gain and reinvests the proceeds the same day, paying 0.005% stamp duty on each purchase. In year 10 everything is sold. No other equity gains are realised in any year.

In year 1 the whole holding had only ₹1,19,994 of gain, so all of it was sold and bought back. After that, the amount that has to be sold shrinks, because older units carry more gain per rupee.

Now the sale in year 10:

Harvesting leaves the investor ₹1,44,977 better off: ₹1,45,644 less tax, less about ₹670 of value lost to the extra stamp duty. That is close to 13% of the ₹11.2 lakh of exemption used across nine years, which is the whole mechanism. The capital gains tax calculator shows the rate on any single year's gain.

Two things the table does not do. It does not make the fund grow faster; the value at the end is the same. And it is not a deferral trick: the saved tax is never paid, because each year's ₹1.25 lakh was exempt when it was booked.

FIFO decides which units go

Mutual fund redemptions follow first in, first out: the oldest units leave first. For a lump sum that works in your favour, since the original units are the ones carrying long-term gain. It also creates a timing trap. In year 2 of the example, every unit held had been bought at the year-1 harvest. Sell them exactly one year later and the gain is short-term, taxed at 20%, with no exemption. A unit must be held for more than 12 months, which is why each harvest is a few days later than the last.

With a SIP, FIFO means a harvest sells the earliest instalments, which usually carry the most gain per rupee, so less has to be sold. The units you rebuy then sit behind all your later instalments in the queue. Our post on how SIP redemptions are taxed shows how the lots line up.

The costs that can cancel it out

Exit loads. The saving is at most about ₹16,250 a year, so a load of even 1% on a large redemption can swallow it. Loads vary widely, so read the exit load before every harvest:

The last row is the one to notice. In a fund with a two-year load, the year-2 harvest above would sell units bought at the year-1 harvest, now 366 to 730 days old. A 1% load on 90% of ₹11.67 lakh is about ₹10,500, against ₹16,250 of tax saved. Harvest only units more than two years old in such funds, even if that means using less than the full exemption. Many index funds carry no load or a very short one.

Time out of the market. A redemption pays out in a day or two, so the sell and buy can land on different NAVs. On a ₹10 lakh redemption, a 1% move between the two costs or earns ₹10,000, which is the same size as the tax saved. Some investors buy first from spare cash and redeem the same day to narrow the gap.

The shared allowance. The ₹1.25 lakh covers all long-term equity gains in the year: shares, equity funds, a rebalancing sale, or a switch between funds. Harvest last, in February or March, once you know what else you have sold.

The ₹12 lakh line. Long-term gains count towards total income for the Section 87A rebate, even when they are tax-free. With ₹11.5 lakh of taxable salary under the new regime, tax is zero. Harvest ₹1.25 lakh of gain and total income becomes ₹12.75 lakh: the rebate goes and the tax is ₹57,200. Harvesting ₹50,000 instead keeps total income at ₹12 lakh and tax at zero.

ELSS. Units bought back in an ELSS fund start a new three-year lock-in.

The rule of thumb

Harvest when you hold long-term equity gains you are not otherwise selling, the fund has no exit load on the units FIFO will sell, and the extra income does not push you across ₹12 lakh. Book up to ₹1.25 lakh, less whatever you have already realised, and buy back the same day. The tax-loss harvesting calculator handles years that hold losses as well, and the guide to mutual fund taxation has the other rates. The CBDT notifications page is the source for any change to the exemption.

What the example does not tell you

A steady 12% is a convenience. Real returns are uneven, and in a falling year there may be no long-term gain to harvest, only losses. The example assumes the exemption stays at ₹1.25 lakh and the rate at 12.5% for ten years, which no Budget promises. It ignores the surcharge on large incomes. None of this is a recommendation of any fund named here.