📚 PASS Investment Adviser (Level 2) Difficulty: Beginner ℹ️ Info   ~5 min read
📌 Chapter 10.3 — Mutual Funds

During a portfolio review for a high-net-worth client, a research analyst notices that a significant portion of the client’s debt mutual fund holdings were redeemed at a loss to rebalance their asset allocation. The client is concerned that these losses are essentially wasted. As an advisor, it is critical to explain that the Income Tax Act provides a mechanism to mitigate this impact: the set-off and carry-forward of capital losses.

Without this knowledge, an advisor might fail to optimize the client’s total tax liability, thereby ignoring a key component of the post-tax return calculation.

In the Indian tax framework, capital losses cannot be treated as a blank check to offset any form of income. Short-term capital losses (STCL) can be set off against both short-term capital gains (STCG) and long-term capital gains (LTCG). However, long-term capital losses (LTCL) have a more restrictive mandate; they can only be set off against long-term capital gains. If a net loss remains after current-year set-offs, it can be carried forward for eight consecutive assessment years, provided the investor files their income tax return within the statutory due date.

Consider an investor who realizes a long-term capital loss of ₹5 lakhs on a gold ETF and a short-term capital gain of ₹3 lakhs from a debt-oriented mutual fund. Under the current rules, the investor cannot use the LTCL to offset the STCG. The STCG is taxed at the slab rate, while the LTCL remains dormant, available only for future long-term gains.

An advisor who understands this hierarchy can plan rebalancing events to ensure that gains are harvested in years where losses are available to absorb the tax impact, effectively improving the client’s internal rate of return.

This framework requires diligent record-keeping of every transaction. Because capital gains and losses are computed based on the specific acquisition cost and indexed cost of acquisition for eligible assets, failure to track these accurately leads to the forfeiture of the carry-forward benefit. Advisors must maintain a robust ledger of all realized losses to guide the client on when to trigger taxable gains, ensuring the portfolio’s tax efficiency is maintained over a multi-year investment horizon.1

Nuance

⚠️ Nuance
The most common pitfall is the assumption that capital losses can be set off against ‘Income from Other Sources’ or ‘Salary.’ Under the Income Tax Act, capital losses are strictly confined to the head of ‘Capital Gains’ for the purpose of set-off. Candidates often mistakenly believe that a loss in one asset class—like equity—is fungible with losses in another—like property—without regard for the specific ‘Short-term vs. Long-term’ constraints, which is a major compliance error.

Check Your Understanding

Practice Question 1

An investor incurs a long-term capital loss (LTCL) of ₹2,00,000 and a short-term capital gain (STCG) of ₹1,50,000 in the same financial year. How can these be adjusted under the Income Tax Act?

Practice Question 2

Under what condition is an investor permitted to carry forward a net capital loss for eight assessment years?

This is a companion read for Section 10.3 — Mutual Funds from PASS Investment Adviser (Level 2) by Akhilesh Gururani, available on Amazon Kindle.

Copyright © 2026 Akhilesh Gururani. All rights reserved.

  1. Indexation benefit is no longer available for most debt-oriented mutual funds acquired after April 1, 2023, making the accurate calculation of nominal capital gains even more vital for tax planning. ↩︎