Capital markets offer the potential for significant returns, but they also carry the risk of losses. These losses, however, are not always entirely negative from a tax perspective. The Indian Income Tax Act, 1961, provides investors with a valuable tool: the ability to set off and carry forward capital losses to reduce the tax liability on the capital gains. This procedure, if understood and used wisely, can remarkably improve and boost one’s tax efficiency.
In this blog, we will explore how capital losses can be set off and carried forward, along with the conditions, limits and tax planning opportunities surrounding them.
Understanding Capital Gains and Capital Losses
A capital gain arises when a capital asset (such as shares, mutual funds, or real estate) is sold at a price greater than its purchase cost. Conversely, when a capital asset is sold for less than the purchase price, it results in a capital loss.
Capital gains and losses are further classified into: –
- Short-Term Capital Gain (STCG)/Loss (STCL): It arises from assets held for a short period. For listed shares and equity mutual funds, the period is less than 12 months.
- Long-Term Capital Gain (LTCG)/Loss (LTCL): Arises from assets held for a longer period. For listed shares and equity mutual funds, the period is more than 12 months.
Different types of assets have different holding periods to qualify as short-term or long-term.
Types of Capital Losses
- Short-Term Capital Loss (STCL): It can be offset against capital gains, whether short-term or long-term.
- Long-Term Capital Loss (LTCL): It can only be set off against long-term capital gains.
Note: From Assessment Year 2019–20 onward, long-term capital losses on listed equity shares and equity-oriented mutual funds are allowed to be adjusted against long-term capital gains due to the re-introduction of tax on LTCG above ₹1 lakh.
Set Off of Capital Losses
Set off refers to the process of adjusting the losses against gains within the same financial year to reduce the taxable income…!
Rules for Set Off:
Short-Term Capital Loss (STCL):
Can be set off against:
- Short-Term Capital Gains. (STCG)
- Long-Term Capital Gains. (LTCG)
Long-Term Capital Loss (LTCL):
Can be set off only against:
- Long-Term Capital Gains. (LTCG)
Restrictions:
- Capital losses cannot be set off against income under other heads like salary, house property, business, or other sources.
- Losses cannot be set off against exempt income.
- Set off is allowed only under the same head of income, i.e., capital losses can be adjusted only against capital gains.
Carry Forward of Capital Losses
If the capital loss cannot be fully set off in the same financial year due to inadequate capital gains, and the remaining loss can be carried forward to the subsequent years…!
Key Provisions
1. Period of Carry Forward:
Unadjusted capital losses can be carried forward for up to eight assessment years immediately succeeding the assessment year in which the loss was incurred.
2. Set Off in Future Years:
- STCL: It can be set off against both STCG and LTCG in subsequent years.
- LTCL: It can be set off only against LTCG in subsequent years.
3. Mandatory Return Filing:
The capital loss must be reported in the Income Tax Return (ITR) filed within the due date under Section 139(1) to be eligible for carry forward.
Example
Assume that in the Financial Year 2024–25:
- You incur a short-term capital loss of ₹1,00,000.
- You earn long-term capital gains of ₹40,000…!
Adjustment in the Same Year:
- STCL of ₹1,00,000 is set off against LTCG of ₹40,000.
- The remaining STCL of ₹60,000 remains unadjusted.
Carry Forward:
- ₹60,000 STCL can be carried forward for up to 8 assessment years.
- In future years, it can be adjusted against STCG or LTCG.
Procedure to Claim Carry Forward
- File ITR Before Due Date: To carry forward capital loss, file income tax return before the due date under Section 139(1), even if your total income is below the taxable limit.
- Use the Correct ITR Form: Individuals should use ITR-2 or ITR-3 (if business income exists) to report capital gains/losses.
- Schedule CFL (Carry Forward of Losses): Report the year-wise required details of carried forward losses in the Schedule CFL section of the ITR form.
Treatment of Losses on Specific Assets
- Loss from Personal Assets: Losses from the sale of personal-use assets like cars, furniture and personal jewellery are not considered capital losses under the Act and cannot be set off or carried forward.
- Crypto and Virtual Digital Assets (VDAs): As per Section 115BBH (applicable from AY 2023–24), no set off or carry forward of losses from the cryptocurrencies or other VDAs is allowed.
- Exempt Capital Gains: Losses cannot be set off against capital gains that are exempt from tax. (such as gains from agricultural land or from assets covered under Section 54 exemptions).
Strategic Tips for Investors
- Tax-Loss Harvesting: Before the end of the financial year, sell loss-making investments to set off against taxable capital gains, and rebalance your portfolio.
- Track Losses Efficiently; Maintain a spreadsheet or use portfolio tracking tools to record details of purchase, sale, holding period and loss amounts.
- Prioritise Set Off of LTCL: Since LTCL can only be set off against LTCG, it ensures you use them first when both STCL and LTCL exist.
- File ITR on Time: Missing the ITR deadline can result in the loss of the ability to carry forward capital losses, even if there is no income.
Conclusion
The facility to set off and carry forward capital losses under the Income Tax Act, 1961, offers investors a legitimate and beneficial way to reduce their tax liability. By understanding and leveraging these provisions, individuals can make their investment strategy more tax-efficient and retain more of their returns.
Filing returns on time, maintaining proper records and planning gains and losses strategically are essential for maximising the benefits of these rules. While capital losses may seem undesirable, when used smartly, they can become a useful tax planning tool.
Frequently Asked Questions
1. Can I set off capital loss against salary income?
No, capital losses can only be set off against capital gains.
2. What is the time limit to carry forward capital loss?
Capital losses can be carried forward for the 8 assessment years.
3. Is filing ITR mandatory to carry forward losses?
Yes, ITR must be filed within the due date to carry forward the losses.
4. Can LTCL be set off against STCG?
No, LTCL can only be set off against LTCG.
5. Can capital losses be carried forward if I missed the return deadline?
No, the right to carry forward the loss is lost if the return is not filed on time
