Pay zero tax on stock, MF gains? Here's how investors can use capital losses to wipe out liability

As equity markets continue to swing wildly, many investors are staring at a mix of capital gains and painful losses in the last quarter of the last financial year. But there’s good news. Those losses can actually wipe out your tax liability if used wisely. For taxpayers dealing with both long-term and short-term capital losses in FY 2025–26, the Income Tax Act offers clear, strategic rules to reduce or eliminate tax on gains. From the order of set-off to carry-forward provisions, understanding these nuances is key to tax optimisation. 

"The key to capital loss optimisation lies not only in understanding the set-off rules but also in their judicious application based on tax rates, asset types, and filing discipline. Investors should ideally consult their tax advisors at the end of the financial year to assess portfolio performance and chart out a loss-harvesting strategy if needed. In a taxation landscape that increasingly rewards informed planning, leveraging capital losses smartly isn't just compliance - it's financial intelligence," said CA Niyati Shah, Vertical Head – Personal Tax at 1 Finance.

Long-term capital losses can be offset by long-term capital gains, while short-term capital losses can be used to offset both short-term and long-term capital gains. Losses from a specified business can only be offset against profits from the same business. Any remaining capital losses that cannot be fully offset in the current year can be carried forward for up to 8 assessment years following the year in which the loss was first calculated.

Here’s a step-by-step breakdown of how to make your losses work in your favour—legally and efficiently.

Capital Gains Set-Off Guide for FY 2025–26

Understanding the Basics: Capital Gains and Losses

Type    Holding Period    Example Assets    Tax Rate (FY26)
Short-Term Capital Gain (STCG)    ≤ 12 months    Listed shares, equity mutual funds    20%
Long-Term Capital Gain (LTCG)    > 12 months    Listed shares, non-equity assets    12.5% (post-indexation)

Tax Benefits through Strategic Set-Off Order

For maximum tax efficiency, it is recommended to follow the set-off order outlined below:

Start with Short-Term Capital Losses (STCL)

Offset short-term capital losses against short-term gains (taxed at 20%) and long-term gains (taxed at 12.5%) prioritising higher tax rate impacts.

Proceed to Long-Term Capital Losses (LTCL)

Utilise LTCL against long-term capital gains (LTCG). Remember to avoid wastage of STCL on LTCG that could have been offset by LTCL.

Segregate Asset Types when Necessary

Different types of assets (equity vs. non-equity) have varying tax rates and exemption thresholds. Plan set-off strategies considering these factors, such as the ₹1.25 lakh exemption on LTCG from listed equity under Section 112A.

Strategic order of set-off

Utilise STCL first: Offset high-tax STCG before LTCG.

Apply LTCL next: Target any remaining LTCG to avoid STCL wastage.

Asset-wise planning: Account for LTCG exemptions like Rs 1.25 lakh under Section 112A.

Carry Forward Rules

Report in time: Losses only valid if reported in the ITR filed before the due date (July 31, unless extended).

8-year carry forward: STCL and LTCL can be carried forward only against future capital gains.

Illustration: Mr Das’s FY26 Tax Strategy

Component    Amount (Rs)
STCL    3,00,000
LTCL    2,00,000
STCG   2,50,000
LTCG (listed equity)  3,50,000

Tax Optimisation Plan:

Section 112A exemption: Rs 1.25 lakh

Net LTCG = Rs 2.25 lakh

Offset STCL → STCG becomes Rs 0; Rs 50k STCL left

Offset Rs 50k STCL + Rs 1.75L LTCL = LTCG becomes ₹0

Carry Forward: Rs 25,000 LTCL

Final Outcome:

Component    Before Set-Off    After Set-Off
Taxable STCG    Rs 2,50,000    Rs 0
Taxable LTCG (post-112A)    Rs 2,25,000   Rs 0
Tax Payable    Rs 0    Rs 0
LTCL Carried Forward    —    Rs 25,000