ITR-1 vs ITR-2, AY 2026-27: The ₹1.25L Rule's Defective-Return Trap
CBDT just let salaried taxpayers file the simpler ITR-1 even with some capital gains and a second house property. Most people read that as "great, less paperwork" and stop there. They don't check the three conditions attached to it — and filing ITR-1 when you don't actually qualify doesn't just get rejected quietly. It gets flagged defective, and you're back to square one with the clock still running toward 31 July.
Summary
| Rule | AY 2025-26 (old) | AY 2026-27 (new) |
|---|---|---|
| House properties allowed in ITR-1 | 1 | 2 |
| Capital gains allowed in ITR-1 | None | LTCG under Section 112A, up to ₹1.25 lakh |
| Any short-term capital gain present | Must use ITR-2 | Must use ITR-2 — unchanged |
| Any carry-forward loss, any head | Must use ITR-2 | Must use ITR-2 — unchanged |
| ITR-1 income ceiling | ₹50 lakh | ₹50 lakh — unchanged |
| Wrong form filed | Defective notice, Section 139(9) | Defective notice, Section 139(9) — 15-day cure window |
Where the traps actually are
Trap 1: One rupee of STCG wipes out the entire relaxation
The ₹1.25 lakh limit only applies to LTCG under Section 112A — listed equity shares and equity mutual funds held over a year. It says nothing about short-term gains. If you sold even one equity fund unit before the 12-month mark, or switched a debt fund and booked a ₹500 short-term gain, you are disqualified from ITR-1 entirely — not just for the STCG amount, for the whole return. Your LTCG can be ₹40,000 and still irrelevant; one rupee of STCG forces ITR-2.
Action: before you pick a form, pull your capital gains statement from your broker or RTA and check for any transaction held under 12 months, including automatic dividend reinvestment units and STP/SWP legs in mutual funds — these are easy to miss because they don't feel like "trading."
Trap 2: A second-property loss you can't fully use this year forces ITR-2
The two-house-property relaxation is real, but it doesn't touch the older ITR-1 rule that bars any carried-forward loss, from any head, not just capital gains. If your second property is rented out and the home loan interest under Section 24(b) plus the flat 30% standard deduction exceeds the rental income, you have a loss from house property. Section 71(3A) caps how much of that loss you can set off against salary in the same year at ₹2 lakh. Anything above that cap becomes an unabsorbed loss carried forward to future years — and the moment that happens, ITR-1 is off the table, even though you technically qualify on the "two house properties" and "LTCG under ₹1.25 lakh" counts.
Action: compute the net result from your second property before assuming ITR-1 applies. If (rental income − 30% standard deduction − home loan interest) is a loss bigger than ₹2 lakh, you need ITR-2 for the carry-forward schedule, full stop.
Trap 3: Your DIY grandfathering math decides which side of ₹1.25L you're on
If you hold equity shares or mutual fund units bought before 31 January 2018, your cost of acquisition for Section 112A isn't what you paid — it's the higher of your actual cost or the lower of (fair market value on 31 January 2018, sale price). Get this wrong — most people just use their purchase price — and your computed LTCG can land on either side of the ₹1.25 lakh line. A taxpayer who thinks they've made ₹1.10 lakh in LTCG using raw purchase cost might actually be at ₹1.31 lakh once grandfathering is applied correctly, which silently disqualifies them from ITR-1 despite having filed it.
Action: for any pre-2018 equity holding, pull the 31 January 2018 closing price (NSE/BSE bhavcopy archives have this) before you total your LTCG, not after.
Real example: Salaried, ₹24L CTC, Pune — self-occupied + one rented flat
| Item | Value |
|---|---|
| Gross annual rent, 2nd (let-out) flat | ₹3,00,000 |
| Standard deduction (30%) | ₹90,000 |
| Home loan interest, Section 24(b) | ₹4,50,000 |
| Net loss from house property | −₹2,40,000 |
| Set-off allowed against salary this year (Sec 71(3A) cap) | ₹2,00,000 |
| Unabsorbed loss carried forward | ₹40,000 |
| LTCG on equity mutual funds (Sec 112A) | ₹95,000 |
| ITR form required | ITR-2, not ITR-1 |
Two house properties, check. LTCG under ₹1.25 lakh, check. And still ITR-2 — because of the ₹40,000 carried forward, not because of anything the CBDT press notes actually flagged as a new restriction.
What happens if you file the wrong form anyway
File ITR-1 when any of the three traps apply, and the return doesn't just sit there — the CPC flags it defective under Section 139(9) once it's processed. You get a notice and a 15-day window to refile correctly. Miss that window and the return is treated as if it was never filed at all — which means the Section 234F late fee (₹5,000, or ₹1,000 if total income is under ₹5 lakh) and Section 234A interest on any unpaid tax start applying as though you missed 31 July altogether, even if your original filing was on time.
What to do this week
- Pull your full capital gains statement and check line by line for any short-term leg — including STP/SWP and reinvested dividend units.
- Calculate the net result from every house property you own, including the ₹2 lakh set-off cap under Section 71(3A) — not just whether rent minus interest looks positive.
- If you hold pre-February 2018 equity, recompute LTCG using the grandfathered cost basis before you total it against ₹1.25 lakh.
- If any trap applies, file ITR-2 directly — don't file ITR-1 first and wait for the defective notice; that just burns your cure window against the July 31 deadline.
Getting the form right the first time avoids a notice you don't need with three weeks left on the clock. If you'd rather have someone map your specific income, gains, and property mix once and tell you exactly which form and which numbers apply, start with a diagnosis. Ready for a personalised plan? Start your free diagnosis — 6 questions, 5 minutes.
