The I-T Act allows taxpayers to adjust capital lost with any income or gains made in another year.

One very important aspect of filing returns is the adjustment of losses. The Income Tax (I-T) Act allows taxpayers, under certain conditions, to set-off loss against income or gains, reducing the net tax liability.

If such loss is not fully set-off in one year, it can be carried forward. It is necessary for every taxpayer to understand and take advantage of this facility.

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Inter-source adjustment

You can earn income from salary, house property, business or profession, capital gains and residuary income from other sources.

There cannot be a loss from salary and income from other sources. But, you could suffer losses under other heads of income.

Loss under one head has to be adjusted against any gain under the same head. This is known as Inter-Source Adjustment.

Say, you have two businesses, one is making a loss and the other is profit-making. Then, the loss from the first one can be set-off against profit from the second one.

Similarly, if you have two house properties, one self occupied and the other on rent. Loss from the first property can be adjusted against the income from the second property.

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Inter-head adjustment

If there is some loss leftover, even after setting it off as above. This can then be adjusted against income from other heads. This is called Inter-Head Adjustment.

For instance, if you have a single self-occupied house property bought on mortgage, it will show loss.

Reason: The annual value of a single self-occupied property is taken to be nil and the adjustment of any interest will result in a negative value. Such a loss may be adjusted with salary or business income, if any.

There are two exceptions to this rule. One, losses under capital gains cannot be set-off with income from any other head. Two, loss from business cannot be set-off against salary income.

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Carry forward the loss

Any loss that cannot be set-off against the same or other heads because of inadequacy of income may be carried forward to the subsequent year.

Such a carry-forward exercise can be done for eight years. After eight years, if the loss has still not been adjusted fully, it has to be written off.

Importantly, for carry-forward losses, only Inter Source Adjustment is available in the subsequent years and not Inter-Head.

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Capital gains

Losses under capital gains have a boundary. This means, these have to be adjusted against other capital gain only and not against other incomes.

Long-term capital loss (LTCL) can be adjusted only with long-term capital gains (LTCG), not short-term one. But, short-term capital loss (STCL)can be set-off either with long- or short-term capital gain (STCG).

If the income from some source is exempted from tax, loss from such a source cannot be set-off. Any long-term loss on sale of shares or equity funds cannot be set-off at all, as the long-term gain from the sale of these instruments is exempted. Example:

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The LTCL from shares (Rs 20,000) cannot be set-off, since the LTCG from it (Rs 15,000) is exempted.

LTCL from non-equity funds (Rs 25,000) can be adjusted only with LTCG from gold (Rs 15,000). Therefore, only Rs 15,000 can be adjusted, the balance Rs 10,000 cannot be. Lastly, the STCL from shares (Rs 40,000) can be set-off against the STCG from it (Rs 50,000) and only the balance Rs 10,000 would be taxed.

For being eligible to carry forward and set-off any loss against profits, it is important to file tax returns.

If the loss return is filed after the due date, the I-T department may condone the delay only if it is satisfied with the reason behind you not being able to filing the returns on time.

The writer is Director, Wonderland Consultants.