You can benefit from the variation in prices of shares that he wished to hold for a long time
I met my friend Anish recently. He was quite happy as he had managed to sell a plot of land owned by him at a good price. Anish wanted to use the money to grow his new business. The only issue he faced was the hefty long term capital gains tax he was required to pay as he could not spare the money to buy another property or capital gain bonds. He asked me if there was any other legitimate way to save on the long term capital gains tax.
I asked him about his other capital assets. He mentioned that the only other significant capital asset he had was a large number of shares in two bluechip companies that he had accumulated over the past decade or so. The value of these shares had risen substantially since he had bought them and he was sitting on a fairly large nest egg in the form of these shares.
Anish said he religiously watched the prices of both these shares everyday even though he had no intentions of selling the shares in the near future. He mentioned that though currently these shares were near their all time highs he had seen 10-15% variations in the prices in many years but since he had no intentions of selling the shares it did not affect him.
It was then I suggested to him an idea to benefit from the variation in prices of shares that he wished to hold for a long time. He could sell the shares at the current high price and immediately buy it back. There would be substantial long term capital gains when he sells the shares but it would be tax exempt. Now the cost of the shares in his hand will be the current high price. In case the price significantly falls from here during the year , he can always sell the shares at that lower price and again buy it back at that price. In the process he would be able to book substantial short term losses but continue to hold on to the shares at the now reduced prices.
These realised short-term losses are adjustable against his long-term capital gains. If the shares prices don’t drop he can continue to hold on to the shares and may be repeat this exercise after 1 year is over and substantial long term capital gains have accrued even on the current prices. The only cost in this strategy were the transaction costs in buying and selling shares which have recently fallen to almost negligible levels.
An example will make this clear. Let's say Anish had 1 lakh shares of Company A which he had bought many years back at Rs 10/- and its current price is Rs 200. His current portfolio value is thus Rs 2 crore and he is sitting on an unrealised long-term capital gain of Rs 1.90 crore. As per this strategy, he sells the 1 lakh share at Rs 200 and buys them back at the same price. Now he has realised long-term capital gains of Rs 1.90 crore and the cost of his portfolio holding is Rs 2 crore.The realised long-term capital gains is tax free. If the price during the year falls say to Rs 150 he can again sell the shares at Rs 150 and purchase it back at the same price. Now he has realised short-term capital loss of Rs 50 lakh and his portfolio of 1 lakh shares in Company A now costs him Rs 1.50 crore. The realised short-term capital loss of Rs 50 lakh can be setoff against his any other long-term or short-term gains. It can be sued to set off the short-term capital gains on redemption of debt mutual fund schemes which many such investors have. If on the other hand the price does not fall at all from Rs 200 he can continue to hold the shares as they are. The process can be repeated every time there are significant accrued long-term capital gains in your portfolio.
This kind of strategy to book tax exempt long-term capital gains to increase the cost price of your investment is perfectly legitimate and is called tax harvesting in investment jargon. It works only where the transaction costs are low and in liquid scrips where the price differential in buying and selling is not very high.
Summary Points - Book tax exempt long-term capital gains; continue to hold on to the shares by buying them back at the current price; higher cost enables you to book short-term capital losses should prices fall from there; continue to hold the shares by buying them back after booking the short-term capital loss.
AVAIL BENEFITS
- You can benefit from the variation in prices of shares that he wished to hold for a long time
- Sell the shares at the current high price and then, immediately buy those shares back
- There would be substantial long-term capital gains when you sells the shares but it would be tax exempt
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