Section 74 of Income Tax Act

Section 74 of Income Tax Act mentions that if "Capital gains" computation results in a loss, it will be carried forward to the next year.
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Section 74 of Income Tax Act
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3 min
26-August-2024
Capital assets like shares, bonds, land and property may appreciate in value and result in capital gains for the seller. In this case, they are classified as long-term or short-term profits and taxed at the rates applicable. However, it is also possible to sell some of these assets at a loss. This results in capital losses for the seller. Section 74 of the Income Tax Act, 1961, deals with such losses under the head capital gains.

In this article, we discuss the key provisions of section 74, such as the set-off and carry forward of capital losses.

What is section 74 of the Income Tax Act?

Section 74 of the Income Tax Act contains provisions related to whether capital losses incurred during a financial year can be set off against other eligible gains and incomes. It also tells you the duration over which any unabsorbed capital losses may be carried forward and how such losses can be reduced from capital gains in subsequent assessment years.

Provisions of section 74

The provisions of section 74 deal with three key areas related to losses under the head capital gains. These areas include the rules for setting off the losses against gains within the same source (i.e. capital gains) and against other heads of income (like salary income or income from business). Additionally, section 74 of the Income Tax Act discusses the conditions for carrying forward the losses under head capital gains. You can adjust these losses against eligible gains and incomes in a specific order only. Section 74 goes into the details of the order of setting off capital losses.

Inter-source set-off

As per section 74 of the Income Tax Act, losses from the sale of capital assets can be set off against gains from the sale of other capital assets. This is termed inter-source set-off because the gains and the losses stem from the same source, i.e. the sale of capital assets. However, there are some conditions for setting off short-term and long-term capital losses against specific types of capital gains, as we’ll see later in this article.

Inter-head set-off

Capital losses cannot be set off against other heads of income like salaries and business income. This type of inter-head set-off, i.e. setting off of losses from one head of income (here, capital gains) against other heads of income is not permitted under the Income Tax Act. So, capital losses can only be adjusted against other eligible capital gains.

Carry forward

If all of the capital losses incurred during any financial year cannot be adjusted against eligible capital gains during the relevant assessment year, you can carry the unadjusted losses forward. As per section 74 of the Income Tax Act, such losses can be carried forward to the subsequent assessment years, subject to a limit. Let us check out these limits and conditions for carrying forward capital losses.

Conditions for carry forward of losses

Section 74 of the Income Tax Act specifies the following conditions for carrying forward unadjusted losses under the head capital gains.

  • Any losses not set off during the current assessment year can be carried forward for at most eight assessment years immediately following this AY.
  • Carry forward of losses is only permitted if you file your income tax return within the due date for the current assessment year.
  • Unadjusted capital losses that are carried forward can only be set off against eligible capital gains.
Explore these essential articles on income tax for comprehensive insights

Set-off of capital losses

You can use short-term capital losses to reduce long-term as well as short-term capital gains. However, long-term capital losses can only be used to reduce long-term capital gains.

Order of set-off

Under section 74, short-term capital losses can be adjusted using capital gains without any restrictions, but long-term capital losses can only be adjusted against other LTCG. So, the ideal order for setting off any losses under this head of income would be as follows:

  • Adjust any brought-forward long-term capital losses against LTCG in the current AY.
  • Thereafter, adjust any brought-forward short-term capital losses against LTCG and STCG in the current AY.
  • If you have excess LTCG, adjust any long-term capital losses incurred in the current AY against such gains.
  • If you have excess capital gains in the current AY, adjust them against any short-term capital losses incurred during this year.
  • Any pending unadjusted capital losses should be carried forward as per the provisions of section 74.
That said, this is only a guideline. The optimal order for setting off capital losses can depend on various factors, including the specific amounts of each type of loss and gain, your overall financial situation and your future expectations of capital gains.

Example

Let us discuss an example to understand how setting off capital losses works as per section 74. Say you have the following capital gains and losses in FY 2023-24 (i.e. AY 2024-25):

  • Long-term capital gain (LTCG): Rs. 1,00,000
  • Short-term capital loss (STCL): Rs. 1,50,000
  • Long-term capital loss (LTCL) brought forward from FY 2022-23: Rs. 50,000
Here is how you can set off these losses using these gains:

  • Brought forward LTCL from FY 2022-23 set off against LTCG in the current year: Rs. 50,000
  • STCL from the current year set off against the remaining LTCG: Rs: 50,000
  • Unadjusted STCL from the current year: Rs. 1,00,000
This remaining STCL of Rs. 1,00,000 can be carried forward over the next eight assessment years, to be set off against future capital gains.

Conclusion

Section 74 is crucial for any taxpayer who holds or has sold a capital asset during the financial year. If you have any capital losses in this assessment year, ensure that you adjust them against eligible capital gains to reduce your tax liability. Also, remember to file your ITR within the due date to be eligible for the benefit of carrying unadjusted losses forward.

That said, capital losses cannot help you adjust income from other sources. If you want to reduce your overall tax liability, special mutual fund schemes known as Equity Linked Savings Schemes (ELSS) can help you out. The amount used for investing in mutual funds in this category is tax-deductible up to Rs. 1.5 lakhs. Additionally, any long-term capital gains on equity mutual funds are also tax-exempt up to Rs. 1.25 lakhs. To avail of these tax benefits, compare the mutual funds available on the Bajaj Finserv Mutual Fund Platform and make an informed choice.

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Frequently asked questions

What is section 74 of the Income Tax Act?
Section 74 of the Income Tax Act is a provision that outlines how losses under the head capital gains can be set off and carried forward.

What types of losses can be carried forward under section 74?
Capital losses, whether they are short-term or long-term, can be carried forward under section 74. These losses can be set off against inter-source gains.

For how many years can capital losses be carried forward under section 74?
As per section 74, capital losses can be carried forward for eight assessment years immediately following the current AY.

Can capital losses be set off against any type of income?
No, you can only set off capital losses against capital gains. You can adjust short-term capital losses against LTCG as well as STCG. However, long-term capital losses are adjustable against other LTCG.

Is there any requirement for filing a return to carry forward capital losses?
Yes, to be eligible for the benefit of carrying forward capital losses, you need to file your income tax return within the due date specified by the government.

Can unabsorbed losses from capital gains be carried forward if the return is filed after the due date?
No, if you have any unabsorbed losses under the head capital gains, you need to file your ITR within the due date to be eligible to carry them forward. Any delay in ITR filing will make you lose this benefit.

Can losses under section 74 be set off in the same assessment year?
Yes, you can adjust losses under the head capital gains under section 74 within the same assessment year. However, they can be set off only against capital gains.

Is it mandatory to utilise the capital loss in the subsequent years if there are capital gains?
There is no specific mention of compulsory adjustment of brought-forward losses under section 74. However, it is advisable to adjust any carried forward losses against capital gains in subsequent assessment years, so you can reduce your tax liability.

What happens if the capital losses are not fully set off within the 8-year period?
Any unadjusted capital losses after the eight assessment years allowed are written off. You cannot adjust them against capital gains in the ninth assessment year.

Do capital losses under section 74 affect the basic exemption limit?
No, capital losses under section 74 cannot be used to reduce your overall income to below the basic exemption limit. This is because capital losses can only be adjusted against capital gains, and not against other sources of income.

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