Tax code 2026: One time LTCL set off against STCG removed in final Income Tax Act; what does this mean

The final version of the Income Tax Act, 2025, has withdrawn a proposed one-time relief that would have allowed carrying forward long-term capital losses (LTCL) to be set off against short-term capital gains (STCG). The move alters tax planning assumptions for investors and businesses from the 2026–27 assessment year, and signals the government’s preference for continuity over transitional concessions as it shifts to the new tax framework.

In the original draft of the Income-tax Bill, 2025, the savings clause provided that any capital losses — long-term or short-term — incurred before 1 April 2026 could be carried forward and set off against capital gains under the new Act. Crucially, the language did not explicitly require adherence to the set-off mechanism prescribed under Section 74 of the Income-tax Act, 1961. This omission led many tax professionals to interpret the provision as a one-time relaxation, allowing brought forward LTCL to be adjusted against STCG during the transition.

Such an interpretation raised expectations of a softer migration to the new regime, particularly for taxpayers holding legacy losses from equity, real estate or long-term investment cycles. Had it been retained, the provision could have significantly expanded loss utilisation and reduced tax outgo in the initial years of the new law.

What’s the change

However, the final enacted version of the Income Tax Act, 2025 has decisively closed that window. The revised savings clause now states that brought forward capital losses must be carried forward and set off “in accordance with the manner provided in the repealed Income-tax Act.” This clarification effectively reinstates the restrictions under Section 74 of the 1961 Act. As a result, long-term capital losses can be set off only against long-term capital gains, while short-term capital losses may continue to be adjusted against both short-term and long-term gains.

CA Hita Desai, Partner at NPV & Associates LLP, said the change reflects a conscious policy choice. “The final version of the Act signals a preference for continuity over concession. While earlier drafts suggested a one-time transitional window for broader set-off of capital losses, the enacted law restores the stricter framework of the 1961 Act,” she said. Desai added that although the eight-year carry-forward period for capital losses remains intact, their utilisation is now firmly tied to the character of the gain.

Tax expert CA Dr Suresh Surana echoed this view, noting that the ambiguity in the draft Bill arose from the absence of restrictive language in the savings clause. “The original Bill, introduced in February 2025, gave rise to an interpretation that brought forward LTCL could be set off against STCG under the new Act. The final provision under Section 536(n) now expressly mandates adherence to the repealed Act, removing any scope for broader transitional relief,” he said.

According to Dr Surana, the revision ensures that the transition to the Income Tax Act, 2025 does not result in a substantive change in the treatment of capital losses through transitional provisions. “It preserves the long-standing principle under Section 74 and prioritises consistency and certainty in tax administration,” he added.

Who will be impacted?

The practical impact of the change is expected to be limited, as any transaction planning based on the draft Bill was necessarily provisional. Dr Surana pointed out that the final law provides clear and unambiguous guidance well before the new Act becomes operative in FY 2026–27. This gives taxpayers adequate certainty regarding loss set-off rules before undertaking capital transactions in the relevant financial year.

From a policy standpoint, Desai said the withdrawal also helps preserve revenue neutrality during the transition. “Allowing LTCL to offset STCG, often taxed at higher effective rates, could have led to a material, albeit temporary, erosion of tax collections. While the move may disappoint investors who anticipated greater flexibility, it underscores that the 2025 Act, despite being positioned as a simplification exercise, does not represent a fundamental shift in capital gains taxation.”\

For taxpayers, the main benefit lost is the ability to use historical long-term capital losses more flexibly, particularly for those who would have used them to offset short-term capital gains.

What should taxpayers do now?

With no transitional relief available, taxpayers must plan strictly within the Section 74 framework. Long-term capital losses can be utilised only against long-term gains, while short-term losses retain broader adjustability. Dr Surana advised taxpayers to review asset holding periods and the timing of disposals, particularly in real estate, unlisted shares and long-term investments, to ensure effective utilisation of accumulated LTCL within the permissible eight-year carry-forward window.

In essence, while the Income Tax Act, 2025 introduces a new legislative structure, the capital gains regime remains firmly anchored in the principles of the 1961 Act—leaving investors with continuity, but little additional flexibility, in managing legacy losses.