Chapter 17 What are Short-Term Capital Losses and Long-Term Capital Losses?

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:

• A loss on the sale of a long-term capital asset will be treated as a long-term capital loss (LTCL).
• A loss arising on sale of a short-term capital asset will be treated as a short-term capital loss (STCL).

Tax shields on losses are of three types, namely

• Setting off current year losses is the first benefit. Losses in the current fiscal year can be set off against gains in the current year. There are restrictions on which head of loss can be set of against which head of income, which we shall learn in detail later in this chapter.
• Carry forward of losses is the second tax shield benefit that you get if your gains in the current year are insufficient to offset your losses. All losses, including capital losses, can be carried forward for a period of 8 assessment years following the year in which the loss is booked. However, speculative losses can only be carried forward for a period of 4 assessment years as against 8 assessment years for other losses.
• Losses can also be brought forward from previous years where they have not been fully absorbed by the gains of the previous years.

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.

• Loss from a speculation business cannot be set off against profit from any non-speculation business. For example, losses on intraday trading are classified as speculative losses as they are not intended for delivery. As a result, intraday losses cannot be set off against short-term gains on shares.
• Long-term capital losses (LTCL) can only be set off against long-term capital gains (LTCG) and cannot be set off against short-term capital gains (STCG). However, short-term capital losses (STCL) can be written off against short-term capital gains (STCG) as well as against long-term capital gains (LTCG).
• Losses of any head cannot be set-off against casual income i.e. income from lotteries, crossword puzzles, horse racing, card games, and gambling or betting in any form or nature. Losses from such casual activities can only be set off against income from such casual activities. Also, expenses cannot be claimed against casual income.
• Loss from the business of owning and maintaining race horses cannot be set off against any income other than income from the business of owning and maintaining race horses.
• Loss from an exempted source cannot be set off against taxable income. If income from a particular source is exempt from tax, then the loss from such a source cannot be set off against any other income which is chargeable to tax. For example, till FY2017-18, long-term capital gains were fully exempt from tax. Hence, any long-term losses could not be set off or carried forward for these years when the income was exempt.
• Loss from business specified under Section 35AD cannot be set off against any other income except income from specified business (Section 35AD is applicable in respect of certain specified businesses like setting up a cold chain facility, setting up and operating warehousing facility for storage of agricultural produce, developing and building housing projects, etc).
• With effect from the assessment year 2018-19, loss under the head ‘house property’ shall be allowed to be set-off against any other head of income only to the extent of Rs.2,00,000 for any assessment year. However, the unabsorbed loss shall be allowed to be carried forward to be set-off in the subsequent years as per existing provisions of Section 71B.

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:

• Income from salary.
• Income from business or profession.
• Income from house property (rental income and not capital gains on sale of property).
• Other sources 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.

• Long-term capital loss can be set off only against long-term capital gains.
• Short-term capital losses can be set off against both long-term gains and short-term gains.

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.

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.

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:

Illustration 1:

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?

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

• Capital losses can be set-off against capital gains on the same head during the same financial year based on certain pre-described conditions
• If you cannot set-off a capital loss under the same head during the same financial year, you can carry forward such losses to the next financial year which can then be set-off against capital gains (if any) arising in that year. A capital loss can be carried forward for 8 years from the end of the financial year in which the loss has been incurred
• This is one of the most important points to note. Any capital loss can be carried forward to the next year only if you had declared such losses in your Income Tax Returns and if the tax return is filed before the due date. Remember, late filing of returns actually disqualifies you from getting the loss carry-forward benefit
• You cannot set-off losses on intraday trading against short-term gains on shares. If you have incurred speculative loses through intraday trading, they can only be set-off through speculative income and can be carried forward up to four years only.
• How are profits and losses on futures and options treated for tax purposes? This is a standard confusion that many traders have. Intraday trading has been defined as a ‘speculative business’, whereas F&O trading is not. Income from trading in F&O (both intraday and overnight) on all the stock exchanges can be considered as non-speculative business income. Speculative (intraday trading in equity) loss cannot be offset with non-speculative (F&O) gains, but speculative gains can offset non-speculative losses.
• There is no standard rule that the short-term capital loss has to be first set-off against short-term capital gains before being set-off against long-term capital gains. So, you need to look at the applicable tax rate on various capital gains and try to set-off your capital loss against the capital gain which has the lowest tax rate. You must also take into account your peak tax rate applicable since that is what determines your applicable rate of STCG tax.
• If income from a particular source is exempt from tax, then loss from such a source cannot be set off against any other income which is chargeable to tax. For instance, agricultural income is exempt from tax, hence, if the taxpayer incurs a loss from agricultural activity, then such loss cannot be adjusted against any other taxable income.​ Similarly, any long-term capital losses on equity up to March 2018 cannot be set-off against other long-term gains as the LTCG was exempt fully from tax during this period.