The LTCG Exemption Most Indian Equity Investors Leave on the Table

Almost every article on this topic stops at the arithmetic: book Rs 1.25 lakh of gain a year, save 12.5% tax on it, do it fifteen times instead of once. That math is real and it is settled. What nobody writes about is the part where people actually lose money: the execution.

I have watched people “harvest” and end up worse off than if they had done nothing. They redeemed on a day the NAV had already run up, they tripped the holding-period reset and paid short-term tax at 20%, they had already used the exemption on a stock sale they forgot about, or they harvested an ELSS unit that was still locked. The exemption is free. Getting the mechanics wrong is not.

This post is the operational version. The redeem-and-rebuy steps exactly, the wash-sale rules India does and does not have, the traps, and how to bolt the whole thing onto an annual review so it takes ten minutes and cannot backfire.

The move, in one paragraph

Long-term capital gains on listed equity and equity mutual funds (held over 12 months) are taxed under Section 112A at 12.5%, but the first Rs 1.25 lakh of such gains in a financial year is exempt. That exemption is an annual allowance. It does not carry forward. If you sell seasoned units to realise up to Rs 1.25 lakh of gain, pay zero tax, and immediately buy the same fund back, you have reset your cost basis higher for free. Repeat every year. Buy-and-hold uses the allowance once; harvesting uses it every year.

That is the whole idea. Now the parts that go wrong.

The naive version, and the four ways it loses money

Here is what most people do the first time:

1. Some day in the year, open the app.
2. Redeem units worth “about Rs 1.25 lakh.”
3. Buy the same fund back.

Every step there has a bug.

Bug 1: they redeem by value, not by gain. The exemption is Rs 1.25 lakh of gain, not Rs 1.25 lakh of redemption. If you bought units at Rs 10 lakh cost that are now worth Rs 30 lakh, redeeming Rs 1.25 lakh of value books only about Rs 83,000 of gain (the cost portion is not gain). You under-use the allowance. Conversely, on units that have tripled, redeeming Rs 1.25 lakh of value books far more than Rs 1.25 lakh of gain and you spill over into taxable territory. You have to solve for the redemption amount that produces the target gain.

Bug 2: they forget the allowance is shared. The Rs 1.25 lakh is a single aggregate ceiling across all your equity LTCG in the year: direct shares, every equity fund, ESOP/RSU sales of listed shares, everything under Section 112A. If you already booked Rs 90,000 of long-term gain selling a stock in June, you have Rs 35,000 of room left in the harvest, not the full Rs 1.25 lakh.

Bug 3: they reset the holding period and forget. The units you buy back are brand new lots. Their 12-month clock starts over. If the market drops and you are forced to sell those specific units within a year, they are short-term, taxed under Section 111A at 20%, which is worse than the 12.5% you were avoiding. Harvesting the wrong lots can convert a long-term position into a short-term one.

Bug 4: they eat a NAV gap. Mutual fund redemptions and purchases settle at end-of-day NAV, and buy and sell do not always process on the same NAV date. Redeem today, and the buy-back may get the next day’s NAV. If the fund gaps up 1.5% overnight, you buy back fewer units than you sold. On a Rs 1.25 lakh trade that is a couple of thousand rupees of slippage, which can wipe out a chunk of the tax you saved.

None of these are reasons not to harvest. They are reasons to do it deliberately, which the rest of this post is about.

The wash-sale question: what India does and does not have

This is the single most misunderstood part, and it is what makes the strategy legal.

In the United States, the wash-sale rule blocks you from claiming a loss if you buy a substantially identical security within 30 days. People assume India has an equivalent that would block the immediate rebuy in harvesting. It does not. For capital gains, there is no wash-sale rule at all in India. You can sell to book a gain and rebuy the same fund the same day, and the stepped-up cost basis is fully valid. The Income Tax Act does not care that you repurchased.

What India does have are two narrower anti-abuse provisions, and they matter mostly for the loss-harvesting cousin, not gain harvesting:

Neither of these blocks plain gain harvesting. You are booking a gain, not a loss, and you are not stripping a dividend or a bonus. They only come into play if you start manufacturing artificial losses around corporate actions, which is a different game. For the everyday redeem-and-rebuy on a growth-option fund, there is nothing to trip over.

So the rule of thumb: gains, rebuy freely; losses, do not rebuy around a dividend or bonus date within the stripping windows.

The exact mechanics, step by step

Here is the version that does not backfire. It applies to a growth-option equity mutual fund; direct shares are the same idea with FIFO handled by your broker.

Step 1: pull your long-term holdings and their gains. Every platform (Zerodha Coin, Groww, MF Central, the AMC statement, or a capital-gains statement from a service like the CAMS/KFintech statement) can show you units held over 12 months and the unrealised gain on them. You need the gain figure, not just the value.

Step 2: subtract what you have already used. Check whether you booked any equity LTCG earlier in the year (a stock sale, an SWP, a rebalancing redemption). Whatever gain you already realised comes off the Rs 1.25 lakh. The remaining room is your harvest budget.

Step 3: solve for the redemption amount. You want to redeem the number of units whose realised gain equals your remaining budget. The relationship for a single lot:

gain per unit    = current NAV - cost NAV (of that lot)
units to redeem  = target gain / gain per unit
value redeemed   = units to redeem x current NAV

Mutual fund redemptions are FIFO within a folio: the oldest units go first. That is usually what you want, because the oldest units are the most seasoned and carry the largest embedded gain, so you fill the allowance with the fewest units disturbed. You cannot cherry-pick a specific lot in a fund the way you can eyeball share lots; the FIFO order is fixed. Plan around it.

Step 4: place the redemption. Zero tax is due because the gain is within the exemption. Note the NAV date the platform will apply.

Step 5: rebuy the same amount, same day where possible. Put the buy in on the same day, ideally before the platform’s cut-off (typically 3 PM for equity funds) so both legs get the same NAV date and the gap risk disappears. If the platform settles redemption proceeds T+1 or T+2, you may need spare cash to fund the buy leg immediately rather than waiting for the sale to credit. Do not let the money sit out of the market for two days chasing a technicality.

That is it. Cost basis stepped up, allowance used, tax paid: zero.

The holding-period reset trap, made concrete

This is worth its own worked example because it is the one that actually hurts.

Say you harvest your oldest lot in July 2026. Those units are now fresh: their long-term clock restarts, and they become long-term only in July 2027. Now imagine March 2027 brings a sharp correction and you need to raise cash. FIFO means the fund sells your oldest units first, and after the harvest your oldest units are the ones you just rebought. Any gain on them is short-term at 20%, and any loss can only set off against short-term gains first.

The fix is to never harvest your entire seasoned base. Keep a reserve of old, untouched units so that a forced sale still draws from long-term lots.

Before harvest:  [====== seasoned lots, all >12 months ======]
                  oldest -------------------------------> newest

After naive harvest of the oldest block:
                 [ NEW rebought units ][ remaining seasoned lots ]
                  FIFO sells these first ^  a forced sale hits STCG

Better: harvest a middle slice, keep the oldest seasoned units in reserve
        so a forced sale still lands on long-term lots.

In practice, with FIFO you cannot literally keep the oldest units and sell middle ones inside one folio. The clean workaround is to run the harvest slightly and hold enough total buffer in other seasoned funds that a cash need never forces you into the just-rebought units. Or simply size the harvest so the rebought block is small relative to your emergency liquidity elsewhere.

Folding it into the annual review

The reason people leave this on the table is not that it is hard. It is that there is no April reminder. Make it a fixed item in a portfolio review you were going to do anyway.

ANNUAL EQUITY REVIEW  (do it once, early in the financial year)
   |
   v
1. Tally equity LTCG already booked this FY  -----> remaining exemption room
   |
   v
2. Rebalance to target allocation -------> some of this may already realise gain
   |                                         (counts against the same room)
   v
3. Harvest: fill leftover room to Rs 1.25 lakh from oldest seasoned lots
   |         rebuy same day
   v
4. If any fund is underwater, consider loss harvesting separately
   |         (mind the 94(7)/94(8) windows)
   v
5. Log cost basis and NAV dates for next year's statement

The ordering matters. Do the rebalancing first, because selling an overweight fund to rebalance already realises long-term gain and eats into the same Rs 1.25 lakh. If you harvest first and rebalance second, you can accidentally push total equity LTCG past the exemption and pay tax you did not intend to. Treat the exemption as one shared bucket that both rebalancing and harvesting draw from.

Do it early in the year, not on 31 March. Leaving it to the last week means a bad NAV day, a missed cut-off, or a platform delay can push the trade into the next financial year or force a rushed price.

Edge cases worth knowing

ELSS units are locked for three years. You cannot redeem an ELSS unit until its individual three-year lock-in is up. Harvest only ELSS lots that are past lock-in. The gain is still eligible; the lock is a separate constraint.

Direct equity shares use broker FIFO too. For shares in a demat account, the broker determines which shares are sold on a FIFO basis for cost purposes. The same holding-period-reset logic applies to the shares you buy back. Watch STT (0.025% on the sell side of a delivery trade for shares) and brokerage, which are larger than the near-zero cost on a fund redemption.

Grandfathering on pre-2018 holdings. For equity bought on or before 31 January 2018, the cost for LTCG is the higher of actual cost and the lower of (the fair market value on 31 January 2018, the sale price). Very old lots may show a smaller taxable gain than you expect because of this, so compute gain on the grandfathered cost, not the original purchase price, when you size the harvest.

STT and exit load are usually trivial for funds. STT on equity fund redemption is 0.001%, a rounding error. Most equity funds have no exit load after 12 months. Confirm your specific fund has no residual exit load before you trade, but for a seasoned holding this is almost never a factor.

Do not harvest a fund you were about to exit anyway. If you plan to sell a fund outright this year, the harvesting round trip is pointless friction. Just sell it and use the exemption against that sale.

The loss-harvesting cousin, briefly

Gain harvesting uses up the exemption in an up or flat market. In a down year you have the opposite tool: book losses to set off against gains. Short-term losses set off against short-term or long-term gains; long-term losses only against long-term gains, and unused losses carry forward eight years if you file the return on time.

You can rebuy immediately here too, because India has no gain-side or general loss wash-sale rule. The only trap is the stripping provisions above: do not book a loss on units bought just before a dividend or bonus record date inside the 94(7)/94(8) windows, or the loss gets disallowed. Outside those windows, sell at a loss, rebuy the same fund, and keep your position while banking the set-off.

What actually works

• Do it, but do it by gain, not by value. Solve for the redemption that produces close to Rs 1.25 lakh of realised long-term gain, after subtracting any equity LTCG you already booked this year.
• Same-day rebuy, early in the year. Kill the NAV-gap and cut-off risk by placing both legs the same day and not leaving it to March.
• Rebalance before you harvest. Both draw from the same shared Rs 1.25 lakh bucket; do the involuntary realisations first.
• Keep seasoned units in reserve. Do not convert your whole long-term base into fresh lots you might be forced to sell short-term.
• Stop overthinking the wash-sale. For gains there is no such rule in India. The immediate rebuy is fine. Only loss harvesting around dividend and bonus dates has to respect Sections 94(7) and 94(8).

What does not work is treating this as a value trade, running it in the last week of March, or harvesting units you cannot afford to have reset to short-term. Done right it is ten minutes a year for a guaranteed Rs 15,625 of avoided tax on a full allowance, and it costs nothing but the discipline to put it on the calendar.

Figures and rules here reflect the position for FY 2026-27 as commonly understood and are illustrative, not investment or tax advice. Rates, limits and provisions change, and your own situation will differ, so confirm the current numbers and run your actual gains before acting.