How to set off long-term and short-term capital losses against capital gains in FY 2025-26

Income tax is payable as a percentage of the income or profits you make. However, what about losses? Do you get to reduce them from your salary income? The rules around set-off of losses from one source to another under the Income-tax Act, 1961, are a bit complicated.

In this article, we’ll simplify all that retail investors need to know about the set-off of capital gain losses.

Classification of income for taxation

Under the Income Tax Act, 1961, income is categorised into five heads for computation and assessment:

• Salary
• House Property
• Business or Profession
• Capital Gains
• Other Sources

Set-off of losses from incomes within one head above is called ‘intra-head’ adjustment, while set-off from other sources of income is called ‘inter-head’ adjustment. Our focus for this article will remain on the treatment of losses under the head capital gains.

Capital Gains and Holding Period

Capital gains income or losses arise from the sale of assets, which are typically held for capital appreciation. Capital assets could be equity shares (unless held for trading), mutual funds, real estate, gold, bonds, etc.

The gains or losses from these capital assets are further classified as short-term or long-term based on how long you’ve held the asset before selling.

As a general rule, if the assets have been held for more than 2 years, the asset is considered long-term. But there are certain exceptions to this rule:

Here's a clear and structured table based on the given data:

*Capital gains from the sale of units of a debt-oriented mutual fund acquired on or after April 1, 2023, and market-linked debentures will always be treated as short-term capital gains under Section 50AA, regardless of how long they have been held for.

Set-off of Capital Losses

Inter-head adjustment is not permissible for losses made under the head capital gains, i.e., capital losses can not be set off against salary, business or house property income. One has to carry forward such losses to set them off from future year gains (up to 8 tax years after the loss is incurred) by filing their income tax return within the due date.

However, intra-head adjustment is allowed.

Short-term capital loss (STCL) can be set off against both long-term capital gains (LTCG) and short-term capital gains (STCG). However, long-term capital loss (LTCL) can be set off only against LTCG. Set-off of LTCL against STCG is not permissible.

Let's take a practical example:

Arjun is a salaried employee who, during the financial year (FY) 2025-26, has the following income and losses from different sources:

Since there is a scope for intra-head set off only under the capital gains head, let’s evaluate:

*LTCL can be set-off only against LTCG

^STCL can be set-off against both STCG and LTCG

*House property losses can be set-off against incomes under other heads

^Business losses can not be set-off against salary income

Misconceptions about set-off of losses

Capital loss on the sale of a real estate asset or a loss on the sale of any capital asset can be set off against gains from equity or mutual fund gains.

Business losses other than speculative in nature can be set off against gains from equity or mutual fund gains.

The requirement of having a tax audit is different and applies only if your business turnover crosses a specified threshold. It is not related to the set-off and carry-forward of losses.

I have LTCG of ₹12 lakh and have no other income. Do I need to pay taxes?

Thus, after the ₹1.25 lakh exemption limit under Section 112A and basic exemption limit of ₹4 lakh, the taxpayer will have to pay taxes at 12.5% on ₹6.75 lakh (₹12 lakh - ₹1.25 lakh - ₹4 lakh).

However, since gains on debt-oriented mutual funds are always considered short-term and are taxed at slab rates, i.e., no special rates, and tax rebate is available on debt mutual fund gains.

Understanding the Income Tax Act’s rules on capital loss set-off can make you smart and save some tax.

Whether it’s losses from equity shares, mutual funds, real estate, or gold, you can strategically offset STCL against both STCG and LTCG, while LTCL can be set off only against LTCG. By carrying forward unadjusted losses to future years, you can optimise your tax liability.

However, file your returns on time to claim the carry-forwarded losses for set-off in future years.