Stock market losses can ease your tax burden if you don’t ignore this crucial caveat

Capital losses on listed shares can be adjusted against capital gains under the income tax rules. This set-off can be done within the same financial year, depending on the nature of the gains and losses.

If the losses are not fully utilised in a specific financial year, they can be carried forward for up to eight assessment years. These carried-forward losses can then be used to offset future capital gains, subject to applicable laws.

“Investors can carry forward stock market losses for up to 8 years. This rule applies to both short-term and long-term capital losses. However, the conditions for carry forward and set-off shall remain the same for all these years, meaning carried-forward long-term losses can be used to offset only long-term gains in subsequent years,” says Ritika Nayyar, Partner at Singhania & Co.

However, short-term capital loss (STCL) can be set off against both short-term capital gains and long-term capital gains, according to multiple experts. Investors must also note that neither STCL nor long-term capital loss (LTCL) can be set off against salary and business income or any other head.

Here's what investors must do to benefit from this provision

Capital losses can only be carried forward if you file your income tax return (ITR) within the prescribed deadline. “Even if your total income falls below the taxable bracket, ITR needs to be filed on or before the due date, or else carrying forward the losses would be of no benefit to you,” said Siddharth Maurya, Founder & Managing Director of Vibhavangal Anukulakara Private Limited.

Maurya also noted that this is one of the most neglected aspects of compliance. “Losses need to be recorded whenever the ITR is filed, in order to make them available for reductions in the taxable income of successive years. Losses need to be recorded within the due date,” he said.

The tax department views the timely filing as your formal declaration of the loss; without that record, the loss effectively "lapses" and cannot be used to reduce your tax liability in the next eight years, Nayyar noted.

“Similar to investments in listed shares, losses in investments in listed shares after their Initial Public Offering (IPO) should be realised and are taxable,” Maurya said. However, losses on investments in unlisted shares are treated differently from those on investments in listed shares.

“Held for more than 24 months, unlisted shares are considered, generally, to be long-term, as compared to pension or tax-exempted shares, where the time is less than 12 months. Thus, these are not likely to be set in the same exemption levels or thresholds. Investors should determine the parameters carefully,” he noted.

What are some common mistakes investors make while claiming losses?

From a compliance and advisory perspective, several common errors stand out. Here are some of them listed by the experts:

• Not filing ITR on time: Investors frequently fail to realise losses within the relevant financial year, thereby losing the immediate set-off benefit, while others misconstrue the permissible set-off rules, particularly in relation to LTCL, said Tushar Kumar, Advocate, Supreme Court of India.
• Ignoring FIFO method: Individuals also often ignore how FIFO (first-in-first-out) method works while the tax department computes capital gains, which can lead to unintended tax outcomes, Kumar said. FIFO assumes the oldest shares are sold first. For taxes, this sets the purchase price and holding period, often leading to higher taxable gains, since older shares were usually bought at lower prices.
• Excessive trading: Such a move driven solely by tax considerations, divorced from underlying investment rationale, may impair portfolio integrity and long-term wealth creation, Kumar said.
• Confusing losses: Nayyar noted that many investors confuse notional losses with realised ones. “The law allows deduction only for actual realised losses. Investors also try to misclassify trades and try to offset intraday speculative losses or F&O business losses, which is not allowed under the tax provisions,” she said.
• Unnecessary tax harvesting: At times, investors attempt to harvest losses even when the gains are below the ₹1.25 lakh exemption limit, thereby effectively wasting this limit, she said.

Disclaimer: The views and recommendations made above are those of individual analysts, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.