The primary motivation to invest in stocks is to earn profits. However, losses are inevitable too, especially when the markets are volatile. As exciting as it is to earn profits, they are subject to certain taxes. Understanding how capital gains can be offset with capital losses can help reduce your tax burden in a financial year. This blog will teach you about capital gains and losses and how to offset them for tax optimisation.
What are Capital Gains and Losses?
Whenever you sell an asset such as stocks, equity, gold, etc, for a profit, it is known as a capital gain. These gains are classified as long-term and short-term capital gains. Any profit from selling listed equity shares within 12 months of purchase is a short-term capital gain (STCG). Similarly, any gain from selling shares after holding them for 12 months is known as a long-term capital gain (LTCG).
For instance, if you purchased 100 shares for Rs. 100 each and sold them for Rs. 150 each, the profit is Rs. 5,000. The profit will be classified as STCG or LTCG depending on when the sale is made.
Capital losses, on the other hand, happen when investments like stocks, mutual funds, etc. are sold for less than what they were bought for. Let’s say you bought 100 shares for Rs. 100 each and then sold them for Rs. 90 each. The amount of money that was lost is Rs. 1,000.
Just like capital gains, even losses are classified as short-term and long-term capital losses. Whenever a capital asset is sold for a loss within 12 months of purchase, it is known as a short-term capital loss (STCL). Any loss incurred on the sale of an asset 12 months after purchase is known as a long-term capital loss (LTCL).
Offset Capital Gains and Losses
Before moving on to offsetting capital gains and losses, it’s important to understand their tax treatment. STCG attracts tax at 20% while LTCG are taxed at 12.5% for any sum exceeding Rs. 1.25 lakhs. So, any long-term gains below Rs. 1.25 are exempt from taxes in a financial year.
Any short-term capital loss can be offset against short-term and long-term capital gains. Long-term capital losses can be offset only against long-term capital gains and not short-term ones. Also, capital losses can be set off against only capital gains and not against any other source of income, such as business income, salary, etc.
Here is an example to make things clearer. Let’s assume you have incurred a short-term capital loss of Rs. 30,000, short-term capital gain of Rs. 80,000, long-term capital loss of Rs. 70,000, and long-term capital gain of Rs. 1.5 lakhs. Using the rules mentioned above, short-term capital losses can be offset against short-term capital gains. Your taxable short-term capital gains will be Rs. 50,000 (Rs. 80,000 – Rs. 30,000).
Here is an example to make things clearer. Let’s assume you have incurred a short-term capital loss of Rs. 30,000, short-term capital gain of Rs. 80,000, long-term capital loss of Rs. 70,000, and long-term capital gain of Rs. 1.5 lakhs. Using the rules mentioned above, short-term capital losses can be offset against both short-term and long-term capital gains. Your taxable short-term capital gains will be Rs. 50,000 (Rs. 80,000 – Rs. 30,000).
Similarly, long-term capital losses can only be offset against long-term capital gains, and your taxable long-term capital gains will be Rs. 80,000 (Rs. 1.5 lakhs – Rs. 70,000). According to the tax rules, long-term capital gains up to Rs. 1.25 lakh are exempt from tax, so your LTCG of Rs. 80,000 will not attract any tax liability. Short-term capital gains, however, are taxable at 20% taxes if they arise from equity shares or equity mutual funds where STT is paid.
Tips for Investors
Carry Forward the Losses
In some instances, you might not have sufficient gains to offset the losses incurred. In such cases, the capital losses can be carried forward for up to eight assessment years. Within this period, they can be offset against any future capital gains as per the short and long-term offset gains rules.
File Taxes Promptly
One of the most important things you must do as a responsible citizen is always filing your taxes promptly. This is also needed to carry forward any capital losses or unused losses. Failing to do this attracts penalties and means you have to forego the above-mentioned right.
Tax-Loss Harvesting Helps
At the end of the financial year, don’t forget to look over your investment portfolio to see if there are any losses that haven’t been realised yet. If you have large capital gains, you can lower your tax bill by selling stocks that are losing money. But don’t sell just to lower your tax bill. Use this method only when it helps your portfolio and fits with your investment goals.
If you’re not sure what to do or need help, don’t be afraid to talk to a financial advisor or consultant to make sure you’re making wise investing choices.
While investing, it’s important to focus not only on profit generation but also on tax optimisation. A simple yet effective means of doing this is by offsetting capital gains with losses. To do this, it’s important to understand the different types of capital gains and losses and the rules about offsetting them. Even though losses are inevitable, you can reduce your tax burden once you are armed with the right strategy.
