Setting Off Capital Gains & Losses — Practical Examples
Definition
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.
In Simple Words
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.
Real-Life Scenario
Consider the case of Ramesh, who has the following capital gains and losses in FY 2024-25: • Equity Fund A: STCG of Rs 2,50,000 (redeemed within 12 months) • Equity Fund B: STCL of Rs 1,80,000 (redeemed within 12 months) • Equity Fund C: LTCG of Rs 4,00,000 (redeemed after 12 months) • Debt Fund D: LTCL of Rs 60,000 (redeemed after 24 months) 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.
Key Points to Remember
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%
Numerical Example
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
Test Your Knowledge
4 questions to check your understanding
Long-Term Capital Loss from mutual funds can be set off against:
Summary Notes
STCL can offset both STCG and LTCG; LTCL can only offset LTCG — never STCG
Carry forward of unabsorbed losses for 8 assessment years — ITR must be filed before due date
Tax-loss harvesting: book losses by redeeming losing investments, then reinvest to maintain exposure
India has no wash sale rule (unlike the US) — investors can redeem and reinvest on the same day
Capital losses cannot be set off against salary, business, rental, or any non-capital income