How to turn stock market losses into tax savings

livemint.com:

Stock market losses are never pleasant—whether through direct equities or mutual funds—but they offer a rare silver lining: the potential to reduce your tax liability through capital loss set-offs. Here’s how savvy investors can use this to their advantage.

Capital losses can be set off against capital gains, allowing investors to reduce their taxable income. For instance, short-term capital losses can be set off against both short-term and long-termcapital gains, while long-term capital losses can only be set off against long-term capital gains.

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Consider this example: A incurs a short-term capital loss (STCL) of ₹5 lakh in year one. He can carry forward this loss to the next year. In year two, he makes a long-term capital gain (LTCG) of ₹11 lakh. By applying the ₹5 lakh brought forward from the previous year's STCL, his net taxable LTCG reduces to ₹6 lakh.

Now, let’s assume a different scenario where A's STCL remains ₹5 lakh in year one, but his LTCG in year two is only ₹2 lakh. In this case, the remaining ₹3 lakh STCL can be carried forward to year three. Losses can be carried forward for up to eight assessment years.

When applying capital losses, you must offset the entire loss from one transaction against gains from another, and the net capital loss or gain is calculated accordingly. Partial set-offs, where only a portion of the loss is used to reduce taxable gains, are not allowed.

“If the loss from one transaction is ₹5 lakh and the gain from another transaction is ₹10 lakh, the tax-payer cannot decide to just use ₹2 lakh of loss for setting-off against the gain and carry forward the remaining loss to the next year," points out Prakash