Set Off and Carry Forward of Losses Under Indian Tax Law

Indian income tax law lets you use a loss in one place to reduce tax owed elsewhere, and the mechanics are called the set off and carry forward of losses. The rules work in two stages. First, in the year the loss arises, you adjust it against other income you earned that same year, first within the same category and then, within limits, across categories. Whatever loss is left after that adjustment can be carried into future years and set against specific types of future income, usually for up to eight years. The framework runs under the Income Tax Act, 1961 for returns covering financial years up to 2025–26, and under the Income Tax Act, 2025 for income earned from April 1, 2026 onward. Section numbers change; the core rules do not.1Income Tax Department. Objective and Scope of the New Act

Step One: Adjust Losses Within the Same Head of Income

The first move is always within a single head. Run two businesses, one profitable and one loss-making? Net them against each other before touching anything else. Own two shares, one sold at a short-term gain and one at a short-term loss? Same idea.2The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 108

Capital gains carry an internal rule that catches people out. A long-term capital loss can be set off only against a long-term capital gain. A short-term capital loss is more flexible: it can offset either a short-term or a long-term capital gain. The direction is one-way. Long-term losses do not reach down to short-term gains.3The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 111

Speculative business losses live in a sealed compartment. A speculative transaction is one where a contract to buy or sell commodities or shares is settled without actual delivery. Losses from such transactions can be set off only against speculative profits, never against regular business income.

Step Two: Set Off Across Different Heads of Income

Once you have netted within each head, any loss still standing can generally be applied against income under a different head in the same year. A net loss under house property can reduce your salary income. A business loss can reduce rental income or interest income.4Income Tax Department. Set Off/Carry Forward of Losses

Three restrictions do most of the work here, and they trip up taxpayers repeatedly.

Business losses cannot be set off against salary. If your business ends the year in the red after intra-head netting, the remaining loss can reduce house property income, capital gains, or income from other sources, but salary is off limits. This restriction also applies where the business loss is caused by depreciation.5The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 109(1)(a)

House property losses are capped at ₹2 lakh per year when set off against other heads. If your net house property loss is ₹5 lakh, only ₹2 lakh reduces your salary or other income this year. The remaining ₹3 lakh moves into carry forward.6The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 109(1)(b)

Capital losses cannot cross over at all. A net capital loss for the year cannot reduce salary, business income, house property income, or income from other sources. It must be carried forward and used against future capital gains.7The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 109(2)

Step Three: Carry Forward to Future Years

Losses that survive both stages roll into future years. What they can offset in those years, and for how long, depends on the type of loss.

  • Business losses (non-speculative): up to eight years, and only against future business or professional income.8The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 112
  • Capital losses: up to eight years. Long-term losses remain restricted to long-term gains; short-term losses can offset any capital gain.9The Income Tax Bill, 2025. The Income-Tax Bill, 2025 – Section 111(3)
  • House property losses: up to eight years, and only against future house property income.
  • Speculative business losses: up to four years, and only against speculative profits.
  • Losses from owning and maintaining racehorses: up to four years, and only against income from the same activity.10Income Tax Department. Income Tax Act, 1961 – Section 74A

The clock starts from the year the loss was first computed, not the year you first try to use it. A business loss from Tax Year 2026–27 must be absorbed by Tax Year 2034–35 or it expires permanently.4Income Tax Department. Set Off/Carry Forward of Losses

File Your Return on Time or Lose the Right to Carry Forward

This is where real money slips away. Under Section 80 of the 1961 Act, a loss can be carried forward only if you filed your return by the due date under Section 139(1). A late return wipes out carry-forward eligibility for business losses, capital losses, speculative losses, and racehorse losses. The loss itself doesn’t vanish for that year’s set-off, but the option to use it in future years does.11Indian Kanoon. Section 80 in The Income Tax Act, 1961

For Assessment Year 2026–27, the last year under the 1961 Act, the deadlines are:

  • July 31, 2026 for individuals and other taxpayers not subject to audit.
  • October 31, 2026 for businesses and professionals whose accounts must be audited.
  • November 30, 2026 for cases involving transfer pricing reports.
12Income Tax Department. Income Tax Returns

Two exceptions. House property losses can be carried forward even with a late return; Section 80 does not extend to them.13Income Tax Department. Income Tax Act, 1961 – Section 139 Unabsorbed depreciation is also untouched by the deadline rule, because it sits under Section 32(2) rather than the loss carry-forward framework.

Unabsorbed Depreciation Follows Different Rules

Unabsorbed depreciation is often confused with a business loss, and the confusion is costly. Under Section 32(2) of the 1961 Act, when a year’s depreciation exceeds the business income available to absorb it, the excess is treated in the following year as if it were that year’s depreciation. That legal fiction produces three practical differences from an ordinary business loss.

First, unabsorbed depreciation has no time limit. It can be carried forward indefinitely until fully absorbed, whereas business losses expire after eight years. Second, because it merges into the current year’s depreciation allowance, it can reduce income under any head, not just business income. Third, it survives a late-filed return, since the Section 80 timely-filing rule does not apply to it.

The order of absorption within a year is fixed: current-year depreciation first, then brought-forward business losses, then unabsorbed depreciation from earlier years.

Extra Rule for Closely Held Companies: The 51% Shareholding Test

A company in which the public does not hold a substantial interest faces an added hurdle. Under Section 119 of the 2025 Act (Section 79 of the 1961 Act), the company can carry forward and set off prior-year losses only if the persons beneficially holding at least 51% of the voting shares on the last day of the set-off year are the same persons who held that stake when the loss was incurred.14Indian Kanoon. Section 119 in The Income Tax Act, 2025

If more than 49% of the voting power changes hands between the loss year and the set-off year, the losses are forfeited. Ownership changes caused by the death of a shareholder or by a gift to a relative are excluded from this rule. Amalgamation or demerger of a foreign holding company may qualify for relaxation under prescribed conditions.

Eligible startups get a wider door. A startup can carry forward its losses despite a shareholding change if every shareholder who held voting shares in the loss year still holds those shares in the set-off year, and the loss was incurred within the first ten years of incorporation.14Indian Kanoon. Section 119 in The Income Tax Act, 2025

What Changes Under the Income Tax Act, 2025

The 2025 Act replaces the 1961 Act for income earned from April 1, 2026 onward. Returns filed in 2026 for Financial Year 2025–26 still run on the old Act. From Tax Year 2026–27, the new numbering applies.1Income Tax Department. Objective and Scope of the New Act

The set-off and carry-forward provisions map across as follows:

  • Intra-head set off: Section 70 becomes Section 108.
  • Inter-head set off: Section 71 becomes Section 109.
  • Business loss carry forward: Section 72 becomes Section 112.
  • Speculative loss: Section 73 becomes Section 113.
  • Capital loss carry forward: Section 74 becomes Section 111.
  • Shareholding condition for companies: Section 79 becomes Section 119.
15Income Tax Department. FAQs on Interplay and Transition

Losses incurred before April 1, 2026 continue to carry forward under the new Act, but they follow the rules that applied when the loss arose, and the carry-forward period runs from the original year. A business loss from Assessment Year 2023–24 keeps its eight-year window starting from that year.4Income Tax Department. Set Off/Carry Forward of Losses

One terminology change is worth noting. The 2025 Act replaces “Assessment Year” with “Tax Year.” Tax Year 2026–27 refers to income earned during Financial Year 2026–27, removing the one-year lag that ran through the old system.1Income Tax Department. Objective and Scope of the New Act