Can stock market losses offset mutual fund gains? What is tax-loss harvesting strategy, how it works

Investors may make profits on mutual fund investments while holding stocks that are trading at a loss. In such cases, selling loss-making stocks could help reduce their tax liability by offsetting capital losses against eligible capital gains.

Short-term capital losses can be set off against both short-term and long-term capital gains, whereas long-term capital losses can be set off only against long-term gains. These rules apply subject to the relevant income-tax provisions.

When can you offset stock losses against MF gains?

Yes, offsetting capital losses from the sale of listed shares is allowed but only against equity-oriented mutual funds.

A mutual fund scheme is classified as an equity mutual fund when it invests more than 60% of its total assets in the equity shares of different companies. The balance amount can be invested in money market instruments or debt securities as per the investment objective of the scheme.

What is tax loss harvesting, how it works?

Tax-loss harvesting is a common strategy in which investors sell investments at a loss to offset eligible capital gains and reduce their tax liability for the financial year. The losses can be used to lower the net taxable capital gains.

Here is how tax loss harvesting works in practice:

Suppose you have earned ₹1,00,000 in short-term capital gains (STCG) by selling equity mutual fund units during a certain financial year. At a tax rate of 20%, you would owe ₹20,000 in tax, excluding applicable surcharge and cess.

Now, suppose you also hold stocks with unrealised short-term capital losses of ₹80,000. If you sell these investments and realise the losses, you can offset them against your eligible capital gains, bringing your net STCG down to ₹20,000.

At a 20% tax rate, the amount you would owe on the remaining capital gains would be ₹4,000, excluding applicable surcharge and cess. This would result in a tax saving of ₹16,000. However, this should be done only if you are certain that the loss-making securities do not have any scope of recovery in the near future.

Can you carry forward your capital losses?

Yes, an investor is allowed to carry forward their unused losses for up to eight assessment years immediately following the year in which the loss was incurred.

In this case, unused losses are those that could not be set off against eligible capital gains during the current financial year, either because the investor did not make sufficient capital gains or did not make any gains at all.

You may lose this benefit if you fail to do this

Capital losses can be carried forward only if the taxpayer files the income tax return within the prescribed due date. The ITR filing deadline differs for salaried taxpayers and those with income from business or professional services, but the benefit of tax-loss harvesting applies to all individuals.

Losses need to be recorded whenever the ITR is filed, in order to make them available for reductions in the taxable income of successive years. Losses need to be recorded within the due date

The income tax department treats a return filed within the prescribed due date as the taxpayer’s formal declaration of the loss. If the return is filed late, capital losses generally cannot be carried forward and set off against future capital gains.

As a result, taxpayers may lose the opportunity to use those losses to reduce their tax liability in subsequent years.