New Capital Gains Trap: What the Income Tax Act 2025 Means for Your Mutual Fund Exits

12.5%

LTCG Tax Rate (unchanged)

20%

STCG Tax Rate on Equity

1.25L

LTCG Exemption Limit

Apr 1

New Law Effective Date

What Changed — And Why Nobody Noticed

When the Income Tax Bill 2025 was first introduced in Parliament, it contained a one-time transitional relief: investors could set off long-term capital losses (LTCL) against short-term capital gains (STCG). This was a significant benefit, especially for mutual fund investors sitting on losses from the 2024 market correction.

But here's what happened next: the final Income Tax Act 2025, as passed and notified, quietly removed this provision. The revised savings clause (Section 536) now states that carried-forward capital losses must be set off "in accordance with the manner provided in the repealed Income-tax Act, 1961."

Translation: the old, stricter rules still apply.

The Core Change

Long-term capital losses can ONLY be set off against long-term capital gains. The proposed one-time cross-category relief (LTCL against STCG) has been removed from the final law. If you were planning your March 2026 transactions around this relief, you need to recalculate immediately.

Old Rules vs. New Rules: Side-by-Side

Scenario	Proposed Bill (Draft)	Final Act (What Applies)
LTCL set off against LTCG	Allowed	Allowed
LTCL set off against STCG	Allowed (one-time)	NOT Allowed
STCL set off against STCG	Allowed	Allowed
STCL set off against LTCG	Allowed	Allowed
Carry forward period	8 years	8 years (per 1961 Act rules)

The critical row is the second one. Short-term losses remain flexible — you can use them against both short-term and long-term gains. But long-term losses are locked into long-term gains only.

Example 1: The Tax-Loss Harvester

Priya's Situation

Long-term capital loss (equity MF held >1 year)- Rs 2,00,000

Short-term capital gain (debt MF held <1 year)+ Rs 3,00,000

Long-term capital gainRs 0

Under the proposed bill: Priya could set off Rs 2L LTCL against her Rs 3L STCG, paying tax on only Rs 1L.

Under the final act: Priya CANNOT use her LTCL against STCG. She pays 20% tax on the full Rs 3L STCG = Rs 60,000. The Rs 2L LTCL carries forward, usable only when she has LTCG in future years.

That's Rs 60,000 in tax that Priya expected to partially avoid. For investors with larger portfolios, the difference could be in lakhs.

Example 2: The SGB Investor

Rahul's SGB Scenario

Bought Sovereign Gold BondsSecondary market (stock exchange)

Purchase priceRs 4,800/gram

Current valueRs 7,200/gram

Capital gainRs 2,400/gram

Before April 2026: Rahul assumed SGB redemption gains would be tax-free.

After April 2026: Tax exemption on SGB capital gains applies ONLY to investors who purchased directly from RBI during the original issue. Secondary market buyers like Rahul will pay LTCG tax at 12.5% on gains above Rs 1.25 lakh.

Why This Matters for SGB Holders

Millions of investors bought SGBs through stock exchanges at a discount, expecting tax-free returns. From April 1, 2026, only original RBI subscribers get the exemption. If you bought SGBs on the secondary market, factor in 12.5% LTCG tax on your exit strategy.

What This Means for SIP Investors

If you run SIPs in equity mutual funds, the loss set-off restriction has practical implications for how you manage your portfolio:

Tax-loss harvesting becomes harder. Previously, investors could sell underperforming equity funds (booking LTCL) and redeploy into similar funds, planning to use those losses against any future gains. Now, those long-term losses can only be useful against long-term gains — which means you need LTCG in the same or future years to benefit.

Switching funds has a tax cost. If you switch from one equity fund to another and book a short-term gain, you cannot offset it with carried-forward long-term losses. You'll pay 20% STCG tax on the switch, even if your overall portfolio is in the red.

Timing of exits matters more. Whether a gain is classified as short-term (<12 months for equity MF) or long-term (>12 months) now significantly affects which losses you can use to offset it. Plan your redemptions accordingly.

3 Things to Do Before April 1, 2026

1

Audit Your Unrealized LossesLog into your mutual fund platforms and check which holdings are sitting at a long-term loss. If you have both LTCL and STCG positions, consider whether booking gains/losses before April 1 could save you tax under the current (more flexible) rules.
2

Review Your SGB HoldingsIf you bought Sovereign Gold Bonds on the secondary market, calculate your expected gains. You may want to plan your exit timing differently now that the tax-free exemption won't apply to you.
3

Re-evaluate Your Fund PortfolioUse Sankyaan's Fund Screener to check whether any funds in your portfolio have significant overlap, poor risk-adjusted returns, or would be better off consolidated — especially if a switch might trigger short-term gains you can't offset.

Frequently Asked Questions

Can I still carry forward long-term capital losses?

Yes. You can carry forward LTCL for up to 8 assessment years. However, they can only be set off against long-term capital gains in those years — not against short-term gains.

Does this affect equity mutual fund LTCG taxation?

The tax rate itself hasn't changed — LTCG on equity MFs above Rs 1.25 lakh is still taxed at 12.5%. What changed is the loss set-off rule: you can no longer use LTCL to offset STCG.

When does the new Income Tax Act take effect?

The Income Tax Act 2025 replaces the 1961 Act from April 1, 2026 (Assessment Year 2027-28). All transactions from FY 2026-27 onwards will be governed by the new law.

Are debt mutual fund gains affected?

Debt mutual funds are already taxed at slab rate (no LTCG benefit for funds bought after April 2023). The loss set-off rules apply primarily to equity and equity-oriented funds where the LTCG/STCG distinction matters most.

Should I sell my equity funds before April 1?

Not necessarily. Selling just for tax reasons can hurt long-term returns. But if you have specific positions with both unrealized long-term losses and short-term gains, booking them before April 1 (under the current rules) could be beneficial. Consult a tax advisor for your specific situation.

Disclaimer: This article is published by Sankyaan for informational and educational purposes only. It should not be considered tax or investment advice. Tax laws are subject to change and interpretation. Please consult a SEBI-registered financial advisor or a qualified Chartered Accountant for advice specific to your situation.