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Keeping tax implications in mind while selling investments

If ‘location, location, location’ is the mantra for success in real estate, then ‘timing, timing, timing’ is the mantra for success in investments. It is very important to get your timing right when you want to sell your investments. The other factor you need to keep in mind is the tax implications of selling your investments.

Why this matters?

Like it or not, all investments come with a certain tax liability. However, they are not all taxed equally. The taxation differs based on various factors such as the type of investment, the holding period and the investor’s tax bracket. By being aware of these aspects, it is possible to reduce your tax liability. In other words, you can keep a greater share of your earnings for yourself.

Here are a few steps you can take to reduce your tax liability:

1) Why are you selling?

There always comes a time when you may want to sell your investments. At that point in time, ask yourself the reason why you are selling. Are you selling to fund an expense in your life (buying a house or paying college fees for your children) or do you want to book profits and exit from the investment? If the answer is the latter, it is best to book your profits when the market is at a high.

For example, if you have invested in an equity fund, it can be quite beneficial to sell the fund and book profits when the market is on a bull run. This way, you can maximize your returns on the investment.

2) What investment to sell?
As an investor, it is possible that you have invested in many different assets. You would have invested in equity funds, debt funds, balanced funds and so on. When you plan to liquidate investments to fund a financial goal, it is important to choose wisely which investment to sell. As mentioned earlier, different investments attract different tax rates.

Here is how the time limit is classified for different mutual funds.

Identify which rates are applicable for the different investments. For example, the short-term capital gains (STCG) tax on debt funds depends on the income tax slab you come under. However, equity funds are charged a flat STCG of 15%. So, compare the different tax rates and identify the net tax liability. This way, you can make the most tax efficient decision when you decide to sell.

3) Can you delay selling?
Imagine your son’s wedding is in a month’s time and you need Rs 25 lakh to finance the wedding. That’s a time bound financial expense. Similarly, you may have other expenses that have strict timelines. As a result, the only solution may be to sell your investments immediately to raise the money.

But what if the decision to sell is not time bound? Is it possible to delay the sale? Ask yourself this question because it can help you save tax. For example, by deciding to delay selling of a fund, you would attract LTCG instead of STCG. In most cases, LTCG tax rates are lower than STCG.

However, it's always best to look at the actual tax liability. For example, if you are selling a debt fund, the gains are taxable as per your income tax slab rate. The LTCG is taxable at either 10% flat or 20% with indexation. If you fall in the 5% tax bracket, then STCG would be preferable. But if you fall in the 20-30% tax brackets, then LTCG would be more tax-efficient.

4) Can you spread out your sale?
Another good option is to spread out the liquidation through options such as Systematic Withdrawal Plans (SWPs). An SWP allows investors to withdraw a specific amount of money at regular intervals. SWPs allow investors to access money when they need it so that they can meet their financial needs.

Now, it is possible to spread an SWP over financial years. For example, let's say you started a six-month SWP in January. Then, half the profits would be taxed in the financial year ending in March. The remaining would be taxed in the next financial year. While this may or may not help lower your final tax outgo, the tax payments can be spread out, thus earning you a temporary relief.

The above points help you identify the tax implications you need to consider when you make a sale. However, remember that these shouldn’t be the sole factors for you to consider when you sell an investment. For tips on when to sell, read here.

What next?
It can always be useful to have professional advice regarding your personal financial affairs. In the next article, let’s see how you can use wealth managers and financial advisors to your benefit.

Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.