Stock market losses are never pleasant—whether through direct equities or mutual funds—but they offer a rare silver lining: the potential to reduce your tax liability through capital loss set-offs. Here’s how savvy investors can use this to their advantage.
Set-off against gains
Capital losses can be set off against capital gains, allowing investors to reduce their taxable income. For instance, short-term capital losses can be set off against both short-term and long-term capital gains, while long-term capital losses can only be set off against long-term capital gains.
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Consider this example: A incurs a short-term capital loss (STCL) of ₹5 lakh in year one. He can carry forward this loss to the next year. In year two, he makes a long-term capital gain (LTCG) of ₹11 lakh. By applying the ₹5 lakh brought forward from the previous year’s STCL, his net taxable LTCG reduces to ₹6 lakh.
Now, let’s assume a different scenario where A’s STCL remains ₹5 lakh in year one, but his LTCG in year two is only ₹2 lakh. In this case, the remaining ₹3 lakh STCL can be carried forward to year three. Losses can be carried forward for up to eight assessment years.
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Dos and Don’ts
When applying capital losses, you must offset the entire loss from one transaction against gains from another, and the net capital loss or gain is calculated accordingly. Partial set-offs, where only a portion of the loss is used to reduce taxable gains, are not allowed.
“If the loss from one transaction is ₹5 lakh and the gain from another transaction is ₹10 lakh, the tax-payer cannot decide to just use ₹2 lakh of loss for setting-off against the gain and carry forward the remaining loss to the next year,” points out Prakash Hegde, a Bengaluru-based chartered accountant.
If loss is more than gains, residual loss gets carried forward to next year.
Additionally, capital losses from one asset class, such as stocks, can be set off against gains from another, such as real estate, and vice versa. There are no restrictions on asset classes—whether equity, debt, real estate, or listed and unlisted securities—as long as it involves a capital gains transaction. However, long-term losses can only be set off against long-term gains, while short-term losses can be set off against both short-term and long-term gains. But note that intra-day trading losses don’t qualify.
“Intra-day transactions (stocks bought and sold on same day) are considered under speculative business and hence losses from such transactions are not available for set-off against capital gains,” explains Bhavya Gandhi, chartered accountant at Rashmin Sanghvi & Associates.
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It’s crucial to file your Income Tax Return (ITR) before the due date—31 July for individual taxpayers—if you want to carry forward your capital losses. Those who are subject to audit, such as individuals or partners in firms, can file their ITR by 31 October.
Lastly, taxpayers can take advantage of this provision under both the old and new tax regimes.