Income tax return: How to reduce taxes by setting off losses in stock markets

Fiscal year 2023-24 is hitting its end. If you have participated in equity markets anytime during the financial year, either through mutual funds or by buying individual stocks, you must be in the process of assessing your profits or losses from your transactions.

It’s that time of the year to put all your investment records together and gather the tax saving investment proofs.

If you are seeing more red than green in your equity deals this year, that could be a silver lining. This may help you to reduce your total tax liability.

The income tax laws in India allow offsetting losses from stock markets against earnings to reduce tax liability for that particular year.

This means that stock market investors can adjust losses against the profit of that year and compute the tax amount accordingly.

Let’s delve into details to get a better understanding.

Income heads

Before getting into details of offsetting losses, it is important to know how the income earned by taxpayers is classified under various heads, as per Income Tax Act, 1961.

The I-T Act categorises income under five major heads – salary, capital gains, gains from house property, income from business or profession, and income from any other source.

Gains or losses from the purchase and sale of stocks fall under the umbrella of ‘capital gains’. The Income Tax Act allows offsetting capital losses only against capital gains. Capital loss cannot be set off against income from other heads like salary.

Hence, stock market losses can be set off against stock market gains. But there is one more important catch.

To know more on how to save tax from stock market income, click here

Long-term gains vs short-term gains

Not all losses can be offset against all gains as the time period of the equity holding has to be kept in mind as well. You need to first classify your gains/losses as short-term and long-term.

The holding period of the underlying equity asset would help you determine whether the gains/losses would be counted as short-term or long-term.

Gains or losses in stocks, non-convertible debentures (NCDs) and equity-oriented mutual funds held up to a period of one year are categorised as short-term capital gains/losses and anything beyond that time period would be considered long-term.

For non-equity-oriented mutual funds, gains/losses are called short-term if the holding period is anywhere below three years.

Offsetting rules

According to income tax guidelines, short-term capital losses can be offset against both short-term and long-term capital gains.

However, long-term capital losses can be offset only against long-term capital gains.

After the adjustment, any remaining loss can be carried forward for eight consecutive years, and can be offset against capital gains made in those years.

It is also important to note here that income from equity intraday trading comes under the head of ‘speculative business’ and not capital gains/losses. Speculative business losses can be set off only against speculative business profits. Hence, losses from intraday trading can only be set off with gains from intraday trading and not gains from other forms of equity trade.

Speculative loss can also be carried forward up to next four assessment years from the year in which it was incurred.

Filing ITR is important to avail tax benefits

Interestingly, if you want to carry forward your capital losses to subsequent years, you can do it only if you file your income-tax (ITR) return on time.

You have to submit ITR prior to the deadline in order to extend the loss carry forward period to the next eight assessment years. Even if you do not have any income to show, file your ITR before the due date to benefit from the provision of offsetting.

To sum up

You should carefully assess your losses and gains while availing this benefit of setting off losses and carrying forward losses. Carrying forward losses can only be availed while filing ITR for the financial year FY 2023-24 and assessment year (AY) 2024-25. It’s advisable to file your ITR before the July 31, 2024, deadline to avail this benefit.