Recycling ELSS investments in the time of LTCG – what you should know

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“I love paying high amounts of taxes,” said no taxpayer ever. Nevertheless, as good citizens, there is no way to break up with taxes permanently. All we can do is reduce our tax liabilities by investing in tax-saving financial products.

Equity-linked savings schemes (ELSS) have been quite popular among investors for this reason. ELSS schemes offer dual benefits – capital appreciation through equities and tax deductions. However, in the Union Budget of 2018-19, the government reintroduced long-term capital gains tax (LTCG) on equities.

Read to know if you should recycle your ELSS investments, what with LTCG taxes being the third wheel now.

What is the tax implication?

Earlier, as an ELSS investor, you could claim tax benefits of Rs 1.5 lakh under Section 80C of the Income Tax Act. From April 1, 2018, the government introduced anLTCG tax of 10% on equity mutual funds.

LTCG is a tax levied on the profits gained by investing in assets such as real estate or mutual funds. If your gainsfrom ELSS investments exceed Rs. 1 lakh in a financial year, you will be charged a LTCG tax of 10%. However, you can still claim tax deductions under Section 80C.

For example, you invest Rs. 1.5 lakhs in ELSS on, say, January 20, 2020 and your investment has appreciated to Rs. 3 lakhs on January 21, 2021, your capital gain stands at Rs. 1.5 lakhs.

In case you redeem your investment, a 10 percent LTCG tax will be imposed on the gains exceedingRs. 1 lakh, i.e., Rs. 50,000. The tax amount will be Rs. 5,000.

Should you recycle your ELSS investment?

Recycling of ELSS investments means redeeming your investment as soon as the lock-in period is over, i.e., three years in the case of ELSS funds. The money is reinvested in the same fund again to claim tax benefits. This is common among mutual fund investors as extra investments are not required to save taxes. However, here’s what you need to keep in mind:

  • Take into account the taxation before recycling your ELSS investments. You may lose out on some capital due to the LTCG tax on redemption. This means that the money you redeem cannot be entirely reinvested into the same fund thus reducing your investment value. Even if the tax liability on your ELSS investment is not much, recycling your investment can hamper the growth of your capital in the long run.
  • ELSS schemes invest in a diverse range of equity mutual funds. Equities generatehigher returns in the long run. Should you choose to redeem your ELSS investment after three years, the profits may not be very high due to short-term stock market volatilities. You may even incur a loss if the markets are in a bear run.

By staying invested for longer periods, you can overcome volatility risks. Recycling your investment may not allow you to harness the power of compounding for wealth creation either.

Conclusion

In the long run, ELSS funds can give you the Midas touch thanks to the growth potential of equities. But with the introduction of LTCG taxes, you could lose an amount with repeated redemptions and reinvestments. Use the recycling strategy only when you do not have the resources to invest in fresh funds to get tax benefits. You can always resort to EPFs, PPFs, ULIPs and tax-saving FDs to fulfil your tax-saving objectives.