Stock market losses are never pleasant, whether through direct stocks or mutual funds, but they offer a rare silver lining: the potential to reduce your tax liability through capital loss offsets. Here’s how smart investors can use this to their advantage.
Earnings compensation
Capital losses can be offset by capital gains, allowing investors to reduce their taxable income. For example, short-term capital losses can be offset by both short-term and long-term losses. capital gainswhile long-term capital losses can only be offset by long-term capital gains.
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Consider this example: A incurs a short-term capital loss (STCL) of $5 lakh in the first year. You can carry this loss forward to next year. In the second year, you make a long-term capital gain (LTCG) of $11 lakh. When applying the $5 lakh advanced from the previous year’s STCL, your net taxable LTCG is reduced to $6 lakh.
Now, let’s assume a different scenario where A’s STCL remains $5 lakh in the first year but their LTCG in the second year is only $2 lakh. In this case, the rest $3 lakh STCL can be carried forward to the third year. Losses can be carried over for up to eight evaluation years.
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What to do and what not to do
When applying capital losses, you must offset the total loss from one transaction against the gains from another, and the net capital loss or gain is calculated accordingly. Partial offsets, where only part of the loss is used to reduce taxable profits, are not permitted.
“If the loss of a transaction is $5 lakh and the profit from another transaction is $10 lakh, the taxpayer cannot just decide to use it $2 lakh losses to offset the gains and carry forward the remaining loss to the next year,” says Prakash Hegde, a Bengaluru-based chartered accountant.
If the losses are greater than the gains, the residual losses are carried forward to the next year.
Additionally, capital losses from one asset class, such as stocks, can be offset by gains from another, such as real estate, and vice versa. There are no restrictions on asset classes, whether shares, debt, real estate or listed and unlisted securities, as long as they involve a capital gains transaction. However, long-term losses can only be offset by long-term gains, while short-term losses can be offset by both short-term and long-term gains. But please note that intraday trading losses do not qualify.
“Intraday transactions (shares bought and sold on the same day) are considered speculative businesses and therefore, losses from such transactions are not available to be set off against capital gains,” explains Bhavya Gandhi, chartered accountant at Rashmin Sanghvi & Associates.
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It is essential to file your Income Tax Return (ITR) before the deadline (July 31 for individual taxpayers) if you want to carry forward your capital losses. Those subject to audit, such as individuals or company partners, can file their ITR before October 31.
Finally, taxpayers can take advantage of this provision in both the old and new tax regimes.
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