Short term vs long term capital loss: Navigating the investment terrain

Introduction

For every investor, understanding the difference between short-term and long-term capital losses is important. These losses arise when you sell your investment holdings for less than its actual cost. 

To help you understand it better, this article covers in detail the meaning and difference between short term vs long term capital loss. So, let’s get started. 

Understanding capital loss in investment

Before we dive into the differences between short term vs long term capital loss, let’s understand what capital loss actually is. Simply put, capital loss occurs when you sell an asset like stocks, bonds, or real estate for less than what you paid for it. This loss can be a bitter pill to swallow, but understanding the definition can help you prevent the loss.

There are two types of capital loss in investment: i) short term capital loss ii) long-term capital loss. The primary difference between short-term and long-term capital loss lies in the asset’s holding period.

1. Short-term capital loss occurs when you sell an asset you’ve held for one year or less.

2. Long-term capital loss happens when the asset is in your possession for more than a year before selling. 

Think of it as a marathon, where the journey is longer, and the effects of market trends have a more protracted impact.

Let’s understand this with examples of capital loss. Here we focus on real estate investment to understand both short and long-term capital losses. 

Imagine you buy a property for ₹500,000 and later sell it for ₹450,000. In this scenario, the ₹50,000 difference represents a capital loss.

Now, let’s break it down further:

Short-Term Capital Loss:

If you sell the property within a short period, typically one year or less, the resulting loss is considered a short-term capital loss.

In this example, if you sell the property within a year for ₹450,000, the ₹50,000 loss falls into the category of short-term capital loss.

Long-Term Capital Loss:

If you hold onto the property for more than a year before selling it at a loss, it becomes a long-term capital loss.

For instance, if you sell the property after holding it for two years and incur a ₹50,000 loss, it is classified as a long-term capital loss.

How to set off capital loss on investment?

Let’s understand it one by one. 

1. Short term capital loss set off

Short term capital losses can be offset against both short-term and long-term gains. If your short term losses exceed gains, they can be used to reduce long-term gains, providing a way to minimise overall tax liability.

Imagine you’re an investor who has made the following transactions in a financial year:

Short-term capital gain: Sold Stock A, held for 8 months, for a profit of ₹5,000.

Short-term capital loss: Sold Stock B, held for 10 months, at a loss of ₹3,000.

Long-term capital gain: Sold Real Estate, held for 2 years, for a profit of ₹4,000.

How to set off?

First, you can offset the short-term loss (₹3,000 from Stock B) against the short-term gain (₹5,000 from Stock A). After this set-off, you’re left with a net short-term capital gain of ₹2,000.

If your short-term losses were more than your gains, you could also offset the remaining loss against your long-term gain. In this case, your long-term gains (₹4,000) remain untouched as your short-term gains exceed your losses.

2. Long term capital loss set off

Long term capital losses work a bit differently. They can only be set off against long-term capital gains. You cannot use a long-term capital loss to offset short-term gains. 

However, similar to short-term losses, if your long-term losses exceed your long-term gains, you can carry forward these losses to subsequent years (up to eight years) to offset future long-term gains.

Now, let’s consider a different set of transactions:

Long-term capital gain: Sold an art piece held for 3 years for a profit of ₹7,000.

Long-term capital loss: Sold a rental property, held for 5 years, at a loss of ₹10,000.

Short-term capital gain: Sold Stock C, held for 11 months, for a profit of ₹3,000.

How to set off?

In this case, you cannot use the long-term loss (₹10,000 from the rental property) to offset the short-term gain (₹3,000 from Stock C).

However, you can offset the long-term loss against the long-term gain. So, the ₹10,000 loss is set off against the ₹7,000 gain from the art piece. After the set-off, you’re left with a net long-term capital loss of ₹3,000.

This remaining loss of ₹3,000 can be carried forward to subsequent years (up to eight years) to offset future long-term gains.

Strategies for handling capital losses

Here are two strategies that you can use:

• Portfolio rebalancing: Use the occurrence of capital losses as an opportunity to reassess and rebalance your portfolio. It might be time to diversify or shift your investment strategies.
• Tax loss harvesting: This involves selling off assets at a loss and immediately reinvesting in similar (but not identical) assets. It allows you to realise a loss for tax purposes while maintaining a similar investment position.

All in all, short-term losses can counterbalance capital gains, lowering your taxable income. Consider tax-loss harvesting: sell underperforming assets and realise losses to offset gains from other investments. 

Long-term losses? They enjoy lower tax rates and can even be used to offset ordinary income up to a certain amount. Remember, timing and individual circumstances matter. Also, understand and evaluate short term capital gain vs long term capital gain to know how to offset losses.

Conclusion

Understanding the difference between short-term and long-term capital loss is essential for any investor. It helps make more informed decisions and optimise your tax situation. Remember, every investor’s journey is unique. Stay informed, stay empowered, and let your investment journey be a fulfilling one. To learn more about different investment options, subscribe to StockGro!

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