Section 112A of the Income Tax Act provides a Rs 1.25 lakh annual exemption on Long-Term Capital Gains (LTCG) arising from the transfer of listed equity shares, units of equity-oriented mutual funds, and units of business trusts. This exemption was increased from Rs 1 lakh to Rs 1.25 lakh in Budget 2024 when the LTCG rate was raised from 10% to 12.5%. At first glance, a Rs 1.25 lakh exemption appears modest. However, when used strategically each year through a practice known as tax-loss harvesting or gain harvesting, the cumulative tax savings over a decade of investing can exceed Rs 2 lakh.
The Mathematics of Annual Gain Harvesting
Consider an investor with a diversified equity mutual fund portfolio that has unrealised LTCG. If the investor books exactly Rs 1.25 lakh in LTCG each year by redeeming units with sufficient gains and immediately reinvesting (a process called harvesting), the entire Rs 1.25 lakh is tax-free. The tax saved each year is Rs 1.25 lakh multiplied by 12.5% which equals Rs 15,625, plus 4% cess making it Rs 16,250. Over 10 years, this is Rs 1,62,500 in tax savings at zero real cost, since the investor remains fully invested.
The reinvestment resets the cost base (acquisition cost) of the units to the current market price. This means future gains on the same capital will be computed from a higher base, further reducing the LTCG when those units are eventually sold. The compounding effect of this cost-base reset is often underappreciated. An investor who harvests gains annually for 15 years can effectively reduce the total lifetime LTCG tax on their portfolio by 30-40% compared to a buy-and-hold investor who redeems everything at once.
How to Execute Gain Harvesting Correctly
Step one is to check your mutual fund account statement (available on CAMS or KFintech portals, or through your AMC app) for unrealised LTCG on each folio. Focus on units held for more than 12 months. Step two is to calculate how many units need to be redeemed to book approximately Rs 1.25 lakh in LTCG. Use the FIFO (First In, First Out) method, which is the mandatory computation method for mutual fund gains. Step three is to redeem those units and reinvest the proceeds into the same or a similar fund on the next business day.
Important caveats: if you redeem and reinvest in the same fund, the exit load and expense ratio may apply, though most equity funds have nil exit load after 12 months. The Securities Transaction Tax (STT) of 0.001% on redemption is negligible. There is no wash-sale rule in Indian tax law, so immediate reinvestment in the same fund is perfectly legal and does not disqualify the gain from exemption.
Combining With Tax-Loss Harvesting
In years when markets decline and certain holdings show unrealised losses, investors can use the reverse strategy. Selling loss-making equity units after 12 months creates a long-term capital loss that can be set off against any LTCG exceeding Rs 1.25 lakh. Long-term capital losses on equity can only be set off against long-term capital gains (not against short-term gains or other income), but can be carried forward for 8 assessment years. Selling short-term loss-making units (held less than 12 months) creates short-term losses that can be set off against both STCG and LTCG.
A combined strategy works as follows: in a year where you have Rs 3 lakh LTCG and Rs 80,000 in unrealised long-term losses, sell the loss-making units to realise the Rs 80,000 loss. Your net LTCG becomes Rs 2,20,000, of which Rs 1,25,000 is exempt, leaving only Rs 95,000 taxable at 12.5%. Without harvesting the loss, you would pay tax on Rs 1,75,000. The additional saving is Rs 10,000 in a single year.
Practical Calendar for Investors
The optimal time for gain harvesting is January to March each year, when you have visibility into the full year's gains and can plan the exact redemption amount. Set a reminder to review your portfolio in February, calculate unrealised LTCG, and execute the redemptions before 31 March. Use the Oquilia Capital Gains Calculator to compute your exact LTCG position and determine the optimal redemption amount to fully utilise the Rs 1.25 lakh exemption without overshooting.
Source
Section 112A of the Income Tax Act, AMFI Data, SEBI Circulars