Setting Off Capital Gains & Losses — Practical Examples
The Income Tax Act allows taxpayers to set off capital losses against capital gains to reduce their tax liability. Short-Term Capital Loss (STCL) can be set off...
Setting Off Capital Gains & Losses — Practical Examples
The Income Tax Act allows taxpayers to set off capital losses against capital gains to reduce their tax liability. Short-Term Capital Loss (STCL) can be set off against both Short-Term Capital Gains (STCG) and Long-Term Capital Gains (LTCG). However, Long-Term Capital Loss (LTCL) can ONLY be set off against Long-Term Capital Gains (LTCG) and NOT against STCG. If losses remain unabsorbed after set-off in the current year, they can be carried forward for up to 8 subsequent assessment years — but only if the Income Tax Return is filed on or before the due date. Tax-loss harvesting is a strategy where investors deliberately book losses by redeeming losing investments and then reinvesting, to reduce current-year capital gains tax.
This is one of the most practical and underused areas of tax planning, and it is where a knowledgeable distributor adds enormous value. Most clients see their portfolio as green (profit) and red (loss) funds and feel bad about the losses. But a seasoned advisor sees losses as a tax asset. The rules can be understood through a simple 2x2 grid — short-term and long-term on one axis, gains and losses on the other. STCL is the most flexible — it can be used to reduce both STCG and LTCG. But LTCL is restricted — it can only reduce LTCG. It cannot touch STCG. This asymmetry is crucial for tax planning. The order of set-off matters: first, set off losses against same-type gains (STCL against STCG, LTCL against LTCG). Then, use any remaining STCL against LTCG. If losses still remain, carry them forward. The carry-forward is valid for 8 years, but — and this is critical — the ITR must be filed before the due date of that year. Filing a belated return forfeits the right to carry forward the loss. Tax-loss harvesting is a strategy where investors strategically redeem investments that are in loss near the end of the financial year, book the loss for tax purposes, and immediately reinvest in the same or a similar fund. The key is that an unrealized loss is converted into a realized loss that can offset realized gains. For SIP investors, this is particularly powerful because different SIP installments may have different profit/loss levels.
A Practical Example
Consider the case of Ramesh, who has the following capital gains and losses in FY 2024-25:
Step 1 — Set off STCL against STCG:
STCG from Fund A = Rs 2,50,000
STCL from Fund B = Rs 1,80,000
Net STCG = Rs 2,50,000 - Rs 1,80,000 = Rs 70,000
Step 2 — Set off LTCL against LTCG:
LTCG from Fund C = Rs 4,00,000
LTCL from Fund D = Rs 60,000
Net LTCG = Rs 4,00,000 - Rs 60,000 = Rs 3,40,000
Step 3 — Apply equity LTCG exemption:
Taxable LTCG = Rs 3,40,000 - Rs 1,25,000 = Rs 2,15,000
Step 4 — Calculate tax:
STCG tax = Rs 70,000 x 20% = Rs 14,000
LTCG tax = Rs 2,15,000 x 12.5% = Rs 26,875
Total tax = Rs 40,875 + 4% cess = Rs 42,510
Without any set-off, Ramesh would have paid tax on Rs 2,50,000 STCG + Rs 4,00,000 LTCG = Rs 50,000 + Rs 34,375 = Rs 84,375 + cess. The set-off saved him approximately Rs 41,000.
What Makes This Important
Mathematical Formula
Set-Off Rules: 1. STCL set-off: Against STCG first, then remaining STCL against LTCG 2. LTCL set-off: Against LTCG ONLY (never against STCG) 3. Carry forward: Unabsorbed losses for 8 assessment years Tax-Loss Harvesting Formula: Tax Saved = Loss Booked x Applicable Tax Rate For equity STCL used against STCG: Tax saved = STCL x 20% For equity STCL used against LTCG: Tax saved = STCL x 12.5% For LTCL used against LTCG: Tax saved = LTCL x 12.5%
Step-by-Step Calculation
Tax-Loss Harvesting Example with SIP: Preeti runs a Rs 20,000/month SIP in a mid-cap fund from Jan to Dec 2024. In March 2025, the market has corrected. Her 12 SIP installments: • Jan-Mar 2024 (3 installments, Rs 60,000): Current value Rs 52,000 — Loss Rs 8,000 (units held < 12 months = STCL) • Apr-Jun 2024 (3 installments, Rs 60,000): Current value Rs 55,000 — Loss Rs 5,000 (STCL) • Jul-Sep 2024 (3 installments, Rs 60,000): Current value Rs 63,000 — Gain Rs 3,000 (STCG) • Oct-Dec 2024 (3 installments, Rs 60,000): Current value Rs 64,000 — Gain Rs 4,000 (STCG) Total investment: Rs 2,40,000. Current value: Rs 2,34,000. Unrealized loss: Rs 6,000. But Preeti also has equity LTCG of Rs 3,00,000 from another fund she redeemed. Tax-loss harvesting strategy: Redeem only the loss-making Jan-Jun installments. Realized STCL = Rs 8,000 + Rs 5,000 = Rs 13,000 Set off Rs 13,000 STCL against Rs 3,00,000 LTCG: New taxable LTCG = Rs 3,00,000 - Rs 13,000 - Rs 1,25,000 (exemption) = Rs 1,62,000 Tax = Rs 1,62,000 x 12.5% = Rs 20,250 Without harvesting: Tax on Rs 3,00,000 LTCG = (Rs 3,00,000 - Rs 1,25,000) x 12.5% = Rs 21,875 Tax saved = Rs 21,875 - Rs 20,250 = Rs 1,625 Preeti immediately reinvests the redeemed Rs 1,07,000 back into the same mid-cap fund (or a similar one). Her market exposure is maintained, but she has Rs 1,625 extra in her pocket. Over many years with larger amounts, this adds up significantly.
Frequently Asked Questions
No. Capital losses from mutual funds can only be set off against capital gains. They cannot be set off against salary income, business income, rental income, or any other head of income. This is a fundamental rule under Section 70-74 of the Income Tax Act.
🧠 Quick Quiz
4 questions to check your understanding