How to Set Off and Carry Forward Capital Losses from Mutual Funds

The set-off and carry forward capital loss rules let you use eligible mutual fund losses against capital gains. STCL can be set off against STCG or LTCG, while LTCL can be used only against LTCG. Unused losses can generally be carried forward for up to 8 tax years, subject to timely ITR filing.

Selling a mutual fund at a loss does not always mean the loss is wasted for tax purposes. If you also have capital gains, you may be able to adjust the loss against those gains. If some loss is still left, you may be able to carry it forward and use it in later years.

But to do so, you need to know all about the set-off and carry forward capital loss rules under the Income Tax Act 2025, which took effect from 1st April 2026.

Under the Income-tax Act, 2025, Section 108(2) deals with losses you can set off in the same tax year, while Section 111 deals with any capital loss left over that needs to be carried forward. 

1. Section 108(2) of the IT Act 2025: Current Year Intra-Head Set-Off

Section 108(2) deals specifically with capital losses that arise in the current tax year. It explains which capital gains those losses can be adjusted against before you look at carrying any unused loss forward:

• Short-Term Capital Loss [Section 108(2)(a)]: If the loss comes from a short-term capital asset, it can be set off against gains (either STCG or LTCG) from any other capital asset in the same year.
• Long-Term Capital Loss [Section 108(2)(b)]: If the loss comes from a long-term capital asset, it can be set off only against gains from another long-term capital asset in the same year. So, LTCL can be adjusted against LTCG only, not STCG.

2. Section 111 of the IT Act 2025: Carry Forward Rules

What if you do not have enough eligible capital gains to use the full loss? Section 111 allows the remaining amount to be carried forward.

The carry forward loss 8 years rule means:

• STCL can be carried forward for up to 8 tax years and later adjusted against STCG or LTCG.
• LTCL can also be carried forward for up to 8 tax years, but it can still be adjusted only against LTCG.
• The eight-year period starts from the tax year immediately following the year in which the loss was first computed.

One more point: Under Section 121 read with Section 263(1) of the Income-tax Act, 2025, you need to file your return of loss within the prescribed due date if you want to carry forward an eligible capital loss to future years.

Capital losses stay within the capital-gains head. This means you cannot use a mutual fund capital loss to reduce:

• Salary income
• Bank or FD interest
• Rental income
• Business or professional income

For example, a ₹40,000 mutual fund capital loss cannot be used to reduce ₹40,000 of salary income. Under the new Act, capital losses cannot be set off against income under another head.

If your capital loss cannot be fully adjusted against capital gains in the current tax year under Section 108, the unused amount may be carried forward under Section 111 of the Income-tax Act, 2025.

This is where the carry forward loss 8 years rule applies in the following way:

For example, suppose you have an STCL of ₹1 lakh, but you can use only ₹30,000 against your capital gains this year. The remaining ₹70,000 can be carried forward for up to 8 tax years and set off against eligible STCG or LTCG in those years, provided you meet the applicable capital loss carry forward ITR requirements (which are subject to amendments).

For capital loss carry forward ITR reporting, you do not need to manually work through every set-off outside the return. But you do need to enter your transactions and check that the loss is being carried correctly.

Step 1: Use the Correct ITR

For an individual or HUF:

• ITR-2 is generally used if you have capital gains or losses but no business or professional income.
• ITR-3 generally applies if you also have income from business or profession.

ITR-1 cannot be used if you have a loss that needs to be carried forward

Step 2: Enter the Gain or Loss

Report the relevant mutual fund sale or redemption under Schedule CG, which covers short-term and long-term capital gains and losses.

Step 3: Check the Current-Year Set-Off

Check Schedule CYLA (Current Year’s Loss Adjustment). This shows how current-year losses have been adjusted against eligible income.

For capital losses:

• STCL can be adjusted against eligible STCG or LTCG.
• LTCL can be adjusted only against eligible LTCG.

Step 4: Check Schedule CFL

If some loss remains unused, check Schedule CFL — Carry Forward of Losses. This schedule separately records short-term and long-term capital losses that are being carried forward.

Step 5: File Within the Due Date

This is the step that protects your right to carry the loss forward. Filing the loss return late can mean losing the carry-forward benefit.

When you’re setting-off or carrying forward capital loss, please remember:

• Old losses continue under the new Act: The Income-tax Act, 2025 replaced the 1961 Act from 1 April 2026, but valid losses from earlier years do not disappear. They can continue for the balance of their original carry-forward period. The eight-year clock does not restart.
• FY 2025-26 is a transition case: A return relating to FY 2025-26/AY 2026-27 is still governed by the Income-tax Act, 1961, even if it is filed after 1st April 2026. From Tax Year 2026-27 onward, the 2025 Act applies
• Old vs new tax regime: Choosing the old or new personal tax regime does not change the basic STCL/LTCL set-off and eight-year carry-forward rules. The new-regime restrictions mainly concern specified deductions and certain other losses, such as house-property loss.
• The loss need not come from the same fund: An eligible mutual fund capital loss can be adjusted against eligible capital gains from another capital asset, subject to the STCL/LTCL rules.
• An unrealised fall is not enough: If your fund NAV has fallen but you have not sold or redeemed the units, you normally do not yet have a capital loss to report.

The set off and carry forward capital loss rules can help you use a realised mutual fund loss against eligible capital gains instead of letting it go unused.

Remember the basic rule: STCL can be set off against STCG or LTCG, while LTCL can only be set off against LTCG. If a loss remains, you can generally carry it forward for up to eight tax years, provided you report it correctly and file your return within the due date.

1. Can I set off a short-term capital loss against a long-term gain in 2026?

Yes. Under the short term capital loss set off rules, an STCL can be adjusted against both STCG and LTCG in the same tax year. So, if you have a short-term loss from a mutual fund and a long-term capital gain elsewhere, the loss can be used against that gain.

2. Can a long-term loss be set off against a short-term gain?

No. A long-term capital loss cannot be adjusted against STCG. For LTCG loss adjustment, the loss can be set off only against eligible long-term capital gains. If there is no enough LTCG in the same year, the unused LTCL may be carried forward, subject to the applicable rules.

3. How many years can I carry forward a capital loss?

An eligible unused capital loss can generally be carried forward for up to 8 tax years. The carry forward loss 8 years rule applies to both STCL and LTCL, but the type of gain you can use the loss against later still depends on whether the loss is short-term or long-term.

4. Do I need to file ITR to carry forward a loss?

Yes. For capital loss carry forward ITR purposes, you need to report the loss and file the return within the prescribed due date. If you miss that deadline, you may lose the right to carry forward the unused capital loss to future tax years.

5. Can capital losses be set off against salary?

No. Under the set off rules for capital gains in India, capital losses can be adjusted only against eligible capital gains. They cannot be used to reduce salary, bank interest, rental income, or business income. 

6. What happens to unused losses after eight years?

If an eligible capital loss is still unused after the permitted eight-year carry-forward period, it expires. You cannot carry it forward further or use it in later years. The eight-year period does not restart simply because the loss remains unadjusted.

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