Capital gains are made when you sell a capital asset at a price that is higher than the purchase price. For example, if you bought 400 shares of Tata Steel at Rs.550 and then sold them shares for Rs.700 after two years, it will result in a capital gain of Rs.60,000. This is quite simple. But what if you sold these shares after two years for Rs.300 against your purchase price of Rs.400. In this case, the investor would have made a long-term loss of Rs.40,000. The question now is what can I do with this loss? Don’t worry; the Income Tax Act also addresses such quandaries. Just as you pay taxes when you make capital gains, you will also get a tax shield when you make capital losses. In this chapter, we will dwell on how we can get tax shields when we make losses on our capital assets.
What are capital gains & capital losses?
The profit or gain (if any) that you make on your capital assets when you redeem or sell them is referred to as capital gains. It can be a short-term capital gain (STCG) or a long-term capital gain (LTCG) depending upon the period of holding. The definition of this holding period also varies widely across asset classes as we shall see later. The tax that is applicable to these profits/gains is known as “capital gains tax”.
Conversely, the losses (if any) that you make on your capital assets when you redeem or sell them is referred to as capital losses. For example, if you buy an asset at Rs.500 and sell it at Rs.450, then the loss of Rs.50 will rank as a capital Loss. It can be a short-term capital loss (STCL) or a long-term capital loss (LTCL), depending upon the ‘period of holding’.
What are the types of tax shields on losses?
Broadly, the definition of capital loss is exactly like the case of capital gains. We need to remember two fundamental points here:
Tax shields on losses are of three types, namely
Basic rules of loss set off on an overall basis:
While capital losses pertain only to capital assets, it would be instructive to look at the entire gamut of losses to get a holistic perspective. Here are some key points to note here.
What are capital assets as per the Income Tax Act?
Capital assets typically refer to anything the individual owns for personal or investment purposes. It includes all kinds of property, movable or immovable, tangible or intangible, fixed or circulating. The basic concept is about ownership and this ownership can be of physical assets or financial assets. Within financial assets, they can be title papers or they can be claims. For example, when it comes to equities, only when a share enters your demat account does it become a capital asset. Otherwise, any intraday holdings and futures/options holdings do not qualify as capital assets. This is crucial to understanding the concept of capital gains and losses.
Capital assets are further classified as financial assets and non-financial assets. Financial assets are intangible and represent the monetary value of an ownership title or a financial claim. Stocks (shares), equity funds, debt funds, bonds, deep discount bonds are all examples of financial assets.
A non-financial asset is an asset with a tangible presence and physical value such as real estate, gold ornaments, equipment, machinery, etc.
What exactly are short-term capital losses?
If financial assets like stocks & equity mutual funds are held for less than 12 months, then an investor will either make a short-term gain or a short-term loss on that investment depending on the price at which the asset is sold. This definition is only valid for equity shares that were purchased on a recognized stock exchange and where the STT was paid. However, this definition is modified to 24 months in the case of unlisted shares of companies as the scope of STT does not arise here.
If non-financial assets (typically property, land, building, gold, jewelry) and some financial assets like debt mutual funds, gold ETFs, and Fund of Funds, etc., are held for less than 36 months, then the investor will make either STCG or STCL on that investment. However, effective from the assessment year 2019-10, the definition of holding period for residential property for short-term has been reduced from 36 months to 24 months.
Long-term Capital Gain/Loss (LTCG/LTCL)
If a financial asset is held for more than 12 months, then that asset is treated as a long-term capital asset on which an investor will either make LTCG or LTCL.
If a non-financial asset is held for more than 36 months, then an investor will make either LTCG or LTCL on that investment.
With effect from FY2017-18/ AY2018-19, the holding period for long-term capital gains for all immovable residential properties has been reduced to 2 years from 3 years.
How to set-off capital losses?
You, as a taxpayer, could be earning your income from a salary, house property (rental income), business or profession, capital gains, income from other sources (like interest on FD/RD), etc. There cannot be a loss from salary and income from other sources. However, you could suffer losses under other heads of income such as loss from house property, business loss, and capital loss.
Most of you are familiar with the concept of loss from house property. When you show income on self-occupied property, you are allowed to adjust up to Rs.2 lakh as interest on home loan paid under Section 24 of the Income Tax Act. This is shown as a loss on house property and can be reduced from your total income. But, what about the status of capital losses?
Is it possible to set-off capital losses against other heads income like salary, rental income, other income, etc? Alternatively, is it possible to set off the loss on self-owned house property against my capital gains? The answer is an emphatic ‘no’. We cannot set-off capital losses against the below heads of income:
Similarly, losses on heads like house property also cannot be set off against capital gains. In short, capital losses can only be set off against capital gains only.
For example: If you make a capital loss on a stock market investment, you can set-off this loss against capital gains from a sale of property (if any).
Here are two basic rules to setting-off losses against gains that one should remember.
How to set-off capital losses on stocks & equity mutual funds?
The below table tells you how to set-off capital loss from the sale of stocks, equity mutual fund schemes, and listed debentures & bonds.
Stocks and equity funds (holding more than 65% of AUM in equities | How the capital loss/capital gain set-off works |
---|---|
Short-term capital losses (STCL) | Can be set off against the short-term gains of any capital asset or long-term gains from any capital asset |
Short-term capital gains (STCG) | Can be used to set off short-term losses on other capital assets, but not long-term equity losses of other capital assets or equity funds |
Long-term capital losses (LTCL) | Can be set off against the long-term capital gains from any capital asset |
Long-term capital gains (LTCG) | Taxable at 10% and can be only used to set-off long-term capital losses on equity |
For example: If you made a short-term capital loss on stocks and have a long-term capital gain from the sale of house property in a financial year, you can set-off losses on stock investment against gains on property. The only condition here is that they both should be arising from a capital asset as per the definition under the Income Tax Act.
How to set-off capital losses on non-equity mutual funds & non-financial assets?
Here are the key capital loss set-off rules on sale of property, debt mutual funds (non-equity funds), gold ornaments, gold ETFs (exchange-traded funds) & unlisted debentures. This entire set refers to non-equity assets.
Property, gold, and non-equity funds | How the capital loss/capital gain set-off works |
---|---|
Short-term capital losses (STCL) | Can be set off against the short-term gains of any capital asset or long-term gains from any capital asset |
Long-term capital losses (LTCL) | Can be used to set off against long-term capital gains only arising from other capital assets |
There is an important point to note here. Till March 31, 2018, long-term capital gains on equity was exempt from tax in the hands of the investor. However, effective April 01, 2018, they will attract a flat rate of tax at 10%, without the benefit of indexation, beyond the threshold of Rs1 lakh per financial year. Any long-term losses on equities up to financial year 2017-18 cannot be brought forward for set-off. However, any long-term losses arising on equity in the financial year 2018-19 can be set-off against any long-term gains in the current year and can also be carried for a period of 8 assessment years. This is a point that needs to be remembered.
Can you make a profit and still have losses for tax purposes?
This may sound strange, but the answer is yes! Let us understand with the illustration below:
Manish bought gold worth Rs.50,000 in May 2013 and sold it at Rs.58,000 in May 2018 resulting in a long-term capital gain (held for more than 3 years) of Rs.8,000. How will this gain be treated?
Gold trade details | Capital Gains | Amount | |
---|---|---|---|
Fiscal year bought | FY2013-14 | Value of Sale (A) | Rs.58,000 |
Fiscal Year sold | FY2018-19 | Cost of Purchase | Rs.50,000 |
Index Value of Buy year | 220 | Indexed Cost of Buy (B) | Rs.63,636 |
Index Value of Sale year | 280 | Indexed Gain/loss (A-B) | (-)Rs5,636 |
In the above case, Manish has actually made an absolute gain of Rs8,000 on the sale of gold after 5 years. However, when the indexation benefit is considered and the cost of acquisition is indexed, Manish ends up with a long-term capital loss of (-)Rs5,636. This loss can either be set-off against the current year’s gains or can be carried forward until 8 successive years.
Summarizing the key learnings of loss set-offs