Set-Off and Carry Forward of Losses in Income Tax: Rules, Limits, and Examples for AY 2026-27

If you sold stocks at a loss, earned negative rental income after deducting home loan interest, or had a side business that didn't turn a profit — those losses aren't wasted. The Income Tax Act allows you to set off losses against other income in the same year and carry forward any remaining losses to offset income in future years, reducing your overall tax liability.

Understanding these rules is especially important if you file ITR-2 (which covers capital gains) or have multiple income sources. Here's how set-off and carry forward work for AY 2026-27.

What Is Set-Off of Losses?

Set-off means adjusting a loss from one source or head of income against a profit from another. There are two types:

Intra-Head Set-Off

This means adjusting a loss from one source against income from another source under the same head.

Example: You have two house properties. Property A gives you a net rental income of ₹3,00,000 after deductions. Property B (self-occupied) gives you a net loss of ₹2,00,000 due to home loan interest under Section 24(b). You can set off the ₹2,00,000 loss from Property B against the ₹3,00,000 income from Property A. Your taxable income under "House Property" becomes ₹1,00,000.

Similarly, short-term capital loss from equity can be set off against short-term capital gains from debt funds — both fall under the "Capital Gains" head.

Inter-Head Set-Off

When a loss remains after intra-head set-off (or there's no other income under the same head), you can set it off against income under a different head — subject to specific restrictions.

Example: After intra-head set-off, you still have a house property loss of ₹1,50,000. You can set this off against your salary income, reducing your total taxable income.

The Set-Off Rules at a Glance

Not every loss can be set off against every type of income. Here are the key restrictions:

Critical Restrictions to Remember

1. Capital losses cannot be set off against regular income. If you lost ₹5,00,000 in the stock market, you cannot reduce your salary or rental income by that amount. Capital losses can only be adjusted against capital gains.

2. House property loss set-off is capped at ₹2,00,000 per year. Even if your total house property loss is ₹4,00,000 (say, from large home loan interest deductions), you can only set off ₹2,00,000 against other income heads like salary in the current year. The remaining ₹2,00,000 can be carried forward.

3. Long-term capital loss has a narrower set-off. LTCL can only be set off against LTCG — not even against short-term capital gains. But short-term capital loss is more flexible and can be adjusted against both STCG and LTCG.

4. Loss under "Income from Other Sources" can be set off against any head except salary — but losses from speculative sources like gambling, horse racing, or lottery cannot be set off against anything else.

Carry Forward: Using Losses in Future Years

When your losses exceed the income available for set-off in the current year, the unabsorbed loss can be carried forward to subsequent assessment years. You then set it off against the relevant type of income in those future years.

Carry Forward Rules by Loss Type

The Return-Filing Condition

This is the most commonly missed rule: to carry forward capital losses and business losses, you must file your ITR by the original due date (typically July 31 for individuals without audit requirements). If you file a belated or late return, you lose the right to carry forward these losses.

The one exception is house property loss — it can be carried forward even if you file a belated return.

Practical Examples

Example 1: Salaried Person with Stock Market Losses

Rahul has the following income in FY 2025-26:

Step 1 — Intra-head set-off: Set off STCL (₹2,50,000) against STCG (₹80,000). Remaining STCL = ₹1,70,000. This remaining STCL can also be set off against LTCG (₹1,40,000). Remaining STCL after intra-head set-off = ₹30,000.

Step 2 — Inter-head set-off: Capital losses cannot be set off against salary. So the ₹30,000 STCL is carried forward.

Step 3 — Carry forward: Rahul carries forward ₹30,000 as short-term capital loss to AY 2027-28. He can set it off against any capital gains he earns in the next 8 years.

Rahul's taxable capital gains for AY 2026-27: ₹0 (all gains absorbed by losses).

Example 2: Multiple Properties with Large Home Loan

Priya has the following income:

Step 1 — Intra-head set-off: Set off Property B loss against Property A income: ₹2,40,000 − ₹3,80,000 = net house property loss of ₹1,40,000.

Step 2 — Inter-head set-off: The net loss of ₹1,40,000 is below the ₹2,00,000 cap, so the entire amount can be set off against salary. Taxable salary becomes ₹15,00,000 − ₹1,40,000 = ₹13,60,000.

If Priya's net house property loss had been ₹3,00,000 instead, only ₹2,00,000 could be set off against salary, and the remaining ₹1,00,000 would be carried forward for up to 8 years.

Example 3: Carry Forward from Previous Year

Amit had carried forward a long-term capital loss of ₹1,80,000 from AY 2025-26. In AY 2026-27, he has:

• LTCG from selling a plot of land: ₹5,00,000
• STCG from debt mutual funds: ₹60,000

He can set off the brought-forward LTCL of ₹1,80,000 against the LTCG of ₹5,00,000. His taxable LTCG reduces to ₹3,20,000. He cannot use the LTCL against the ₹60,000 STCG (long-term loss only offsets long-term gains).

Set-Off Rules Under the New Tax Regime

If you've opted for the new tax regime (default from AY 2024-25 onwards), the set-off rules for capital gains and business losses work the same way. However, two things change:

1. House property loss treatment: Under the new regime, you cannot claim deductions under Section 24(b) beyond ₹2,00,000 for self-occupied property (the let-out property interest deduction is uncapped under both regimes). Since most house property losses arise from home loan interest, the quantum of house property loss you generate may differ between regimes.

2. No difference in capital loss set-off: Whether you're in the old or new regime, short-term and long-term capital loss set-off rules are identical. Your regime choice doesn't affect how stock market losses are treated.

Common Mistakes to Avoid

Not filing by the due date. If you had capital losses of ₹3,00,000 but filed your return on September 15 instead of July 31, you cannot carry forward those capital losses. The ₹3,00,000 is simply lost. House property losses are the only exception.

Confusing LTCL and STCL flexibility. Many taxpayers assume all capital losses are treated equally. Remember: STCL can offset both STCG and LTCG, but LTCL can only offset LTCG. If you have both types of losses, set off your LTCL first against LTCG, then use STCL for any remaining gains — this preserves the more flexible STCL for carry forward.

Forgetting to report brought-forward losses. When you file your ITR, you must explicitly report losses carried forward from prior years in Schedule CFL (Carry Forward of Losses). If you skip this, you may not be able to claim the set-off in future years.

Not reporting losses at all. Some taxpayers don't file returns in years when they only have losses, thinking there's nothing to report. But you must file to establish the loss for carry-forward purposes.

How to Report in Your ITR

In ITR-2 (which most taxpayers with capital gains file), losses and carry-forwards are captured in:

• Schedule HP for house property income and losses
• Schedule CG for capital gains and losses, including intra-head set-off
• Schedule CYLA (Current Year Loss Adjustment) for inter-head set-off
• Schedule BFLA (Brought Forward Loss Adjustment) for set-off of losses carried forward from previous years
• Schedule CFL (Carry Forward of Losses) for losses being carried forward to future years

49Tax's AI automatically computes set-off and carry-forward amounts when you enter your income details, so you don't have to manually navigate these schedules.

Key Takeaway

Losses are a tax asset — but only if you file on time and understand the set-off hierarchy. File your return by July 31 even in loss years, prioritize setting off LTCL against LTCG before using STCL, and always check Schedule CFL in your ITR to confirm brought-forward losses are correctly reported. Over 8 years of carry-forward, even a moderate capital loss can save you significant tax when future gains materialise.