The primary aim of investing is to generate profits. However, every investment comes with certain risks, and one risk is that of incurring a loss. Whenever you make a profit from a capital asset, such as mutual funds, shares, property, etc., it is termed a capital gain.
On the other hand, a loss generated from it is known as a capital loss. Incurring a capital loss is not an ideal outcome, but with the right strategy, this can be utilised to reduce future tax liability. Yes, you read it right. There is, after all, a silver lining to capital losses as well.
This article will help you understand the treatment of capital losses and how they can be set off and carried forward for future benefits.
Understanding Capital Losses
You incur a loss when your selling price is greater than the purchase price. This is the same logic applicable to capital assets as well. If the selling price of your capital asset, such as stocks or property, is lower than its purchase price, you incur a capital loss.
Capital losses are classified as short-term and long-term capital losses, depending on the duration for which you hold the asset. If the loss is on an asset held for less than 12 months, it is known as a short-term capital loss (STCL), and if this duration is more than 12 months, it is known as a long-term capital loss (LTCL).
Under the Income Tax Act, 1961, capital losses can be set off and carried forward. Intra and inter-head adjustments can be made to set off a capital loss. Intra-head adjustment refers to adjusting losses within the same income head.
At the same time, inter-head adjustment refers to adjusting the losses left over from the previous step across different income heads. If setting off a capital loss isn’t an option during a specific financial year, your unadjusted losses can be carried forward to the future, subject to specific rules.
How to Offset Capital Losses?
According to the Income Tax Act, 1961, any loss from a capital asset cannot be offset against income generated from any other source. Simply put, capital loss can be set off against capital gains and nothing else. Also, within capital losses, depending on whether it is a short-term or long-term capital loss, the rule to set it off against capital gains varies.
The Income Tax Act states that a long-term capital loss can be set off against only long-term capital gains. However, short-term capital losses can be set off against long-term and short-term capital gains.
How to Carry Forward Capital Losses?
If you incur only capital losses in a given financial year, then they can be carried forward for eight subsequent assessment years following the year in which the loss was first accounted. Here is a simple example to make things clearer.
Let’s assume that during the financial year 2024-25, you incurred a short-term capital gain on the sale of shares worth ₹1.75 lakhs, and long-term capital gain of ₹85,000. A long-term capital loss was carried forward from the previous financial year, that is 2023-24, equivalent to ₹96,000 and a short-term capital loss was incurred in 2024-25 of ₹42,000.
Now, let us see how each of these losses can be set off and carried forward. Given that long-term capital losses can be offset against long-term capital gains, by adjusting both, you end up with an adjusted long-term capital loss of ₹11,000.
Similarly, the short-term capital gain can be used to offset the ₹42,000 loss incurred in the year, giving you a net short-term capital gain of ₹1.33 lakhs. By using the tax rules, the unjust capital loss of ₹11,000 can be carried forward for the next eight assessment years, provided you file taxes on time.
In the same example, if you didn’t have any capital gains whatsoever and incurred both short and long-term capital losses, then the entire sum can be carried forward for up to 8 successive assessment years, provided tax returns are filed within the original due date. Failing to do this results in forfeiting the provision of carrying forward the losses.
Conclusion
Capital losses might seem entirely worthless and are frustrating to deal with. However, with the timely filing of income tax and strategic tax planning, these losses can be carried forward and offset from any future gains to reduce tax liability.
When in doubt, it is always better to reach out to a financial consultant or advisor to make things easy. After all, it is your hard-earned money and making smart and calculated investment decisions is needed to ensure a capital loss is not the end of the road for you.
