Stock market correction: How can investors save taxes despite incurring losses on stocks, mutual funds

Stock Market crash: The Indian stock market has experienced a significant downturn since reaching its peak levels in September 2024, resulting in lower valuations for many stocks and sectors. On Tuesday, the benchmark BSE Sensex dropped by 341.82 points, or 0.47%, to 72,744.12, while the NSE Nifty opened 132.80 points lower, or 0.6%, at 21,986.50. This marked the 10th consecutive day of decline for the Indian stock market, driven by continuous selling from overseas investors.

Investors are facing capital losses due to the ongoing sell-off in the stock market since September 2024. This has had a negative impact on investors of all types, including long-term investors and F&O traders, during the current financial year 2024-25. One way to reduce your income tax is by utilizing provisions in the Income Tax Act that permit taxpayers to offset and carry forward capital losses. This can help lower your tax liability for the current year or up to eight years.

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Short term capital gains tax vs long-term capital gains tax 

According to the Income Tax Act, capital gains are classified into two categories:

Short-Term Capital Gains (STCG): These are profits obtained from selling assets such as equity shares or units of equity mutual funds within a short period. For listed assets, the period is 12 months, and for unlisted assets, it is 24 months. The STCG tax rate was previously 15% but was increased to 20% in Budget 2024.

Long-Term Capital Gains (LTCG): LTCG refers to profits gained from assets held for a longer duration, i.e., over 12 months for listed assets and 24 months for unlisted assets. The LTCG tax rate is 12.5% post-Union Budget 2024, up from 10% previously.

Capital losses are also categorised as short-term capital loss (STCL) and long-term capital loss (LTCL).

It is important to note that LTCG up to Rs 1.25 lakh in a financial year is exempt from tax.

"In a declining stock market, investors may face capital losses on their investments. However, these losses can be strategically utilized to optimize tax liability through Tax loss harvesting. This approach allows investors to offset losses against gains, thereby reducing their overall tax burden. By selling underperforming assets at a loss, investors can neutralise gains from other investments and lower their taxable income. While commonly applied towards the end of the financial year, tax loss harvesting can also be integrated into regular portfolio management for ongoing tax optimisation," explained CA (Dr.) Suresh Surana.

Applicability to LTCG and STCG

> For Short-Term Capital Gains (STCG), equity shares held for 12 months or less are categorized under STCG and are typically taxed at 20% under Section 111A of the Income-tax Act, 1961. Investors can offset short-term capital losses against both STCG and LTCG, allowing them to reduce their taxable gains effectively.

> For Long-Term Capital Gains (LTCG), equity shares held for more than 12 months qualify as LTCG. Gains exceeding Rs. 1.25 lakh from the sale of listed equity shares and equity-oriented mutual funds are taxed at 12.5% without indexation benefits. However, long-term capital losses can only be offset against LTCG, thereby reducing the taxable amount. Also, in accordance with Section 112A, long-term capital gains (LTCG) up to Rs. 1.25 lakh per financial year are exempt from tax. 

"Before utilising long-term capital losses for set-off, investors should assess whether their LTCG falls within this exemption limit, as any gains below this threshold remain non-taxable. This ensures that capital losses are applied efficiently, maximizing the tax-saving potential," Surana added.

Short-term capital losses vs Long-term capital losses

Investors can utilise capital losses to offset capital gains in a given year. For example, if a short-term capital loss of Rs.50,000 is incurred on shares of a company and a short-term capital gain of Rs.50,000 is earned on shares of another company, the losses can be used to offset the gains, resulting in no tax payment for the investors. The rules regarding the set off of capital losses are as follows:

Short-term capital losses (STCL) can be set off against both short-term and long-term capital gains within the same year.

Long-term capital losses (LTCL) can only be set off against long-term capital gains. It is important to note that capital losses cannot be adjusted against any other sources of income, such as salary, business income, or house property income.

Carry forward of capital losses

If the losses cannot be fully offset against gains in the same tax year due to insufficient gains, they will be carried forward for adjustment in future years. For example, if you incur a short-term capital loss of Rs. 50,000 from one company's equity shares in a fiscal year and earn a short-term capital gain of Rs. 30,000 from another company's shares, the unadjusted Rs. 20,000 loss can be carried forward for up to eight years. This loss can then be used to offset taxes on similar gains in the subsequent eight years.

"If capital losses exceed gains in the current year, the remaining losses can be carried forward for up to 8 financial years. However, to claim this benefit, taxpayers must declare the loss in their Income Tax Return (ITR) on or before the applicable due date. Carried-forward losses can be adjusted against eligible capital gains in subsequent years, allowing investors to maximize their tax efficiency over time," Surana explained.

He added that while short-term capital losses can offset both STCG and LTCG, long-term capital losses can only be used to offset LTCG. Given this distinction, tax-loss harvesting serves as an effective tool for managing tax liabilities across both short-term and long-term capital gains. "By leveraging the set-off provisions of the Income-tax Act, investors can significantly optimize their tax efficiency and minimize capital gains tax burdens," he further said.

Effectively managing stock market losses through capital loss set-off and carry-forward provisions can lead to substantial tax savings. To ensure compliance and maximize tax benefits, it is recommended to maintain proper records as well as file tax returns within the due date.