Capital gains refers to appreciation of value compared to initial investment in an asset. Capital gains attracts tax as per provisions of Income Tax Act. However, there are ways to minimize capital gains tax impact on your earnings. This article discusses it in details.
What is capital gains?
Any profit arising out of sale of assets is called capital gains. As per IT Act, such gain or profit is considered as an income in the hand of the recipient in the year of execution. Therefore, tax has to be paid on it.
Example of assets for the purpose of capital gains is land, building, house, vehicle, patent, trademarks, leasehold right, machinery, and jewelry.
Types of capital gains
It is classified in 2 categories – short term capital gains and long-term capital gains.
Short term capital gains refers to capital gains arising from sale of assets within 36 months of acquiring. It is 24 months for land, building and house property. In case of following assets it is just 12 months.
- Equity or preference shares in a company listed on a recognized stock exchange in India.
- Debentures, bonds, Govt. securities etc listed on recognized stock exchange in India.
- Mutual Fund units of UTI
- Units of equity oriented mutual funds
- Zero coupon bonds
Long term capital gains refers to capital gains arising from sale of assets after holding for more than 36 months. In case of land, building and house property it is 24 months. The above 5 category of assets if held for more than 12 months and sold thereafter, the gain will be categorised as long-term capital gains.
In case of an asset acquired by gift, will, succession or inheritance, the period for which the asset was held by the previous owner is also included when determining whether it’s a short term or a long-term capital asset. In the case of bonus shares or rights shares, the period of holding is counted from the date of allotment of bonus shares or rights shares respectively.
Capital gains tax in India
It is defined under section 54 of IT Act. The tax structure is as below:
| Tax type | Asset | Tax rate |
| Long term capital gains | All assets excluding equity shares/units of equity-oriented fund and debt fund without indexation. | 20% |
| equity shares/units of equity-oriented fund debt fund without indexation. | 10% over and above ₹1 lakh. | |
| Debt fund without indexation | 10% | |
| Short term capital gains | When securities Transaction tax (STT) is not applicable. | The gain added to income and tax is paid as per income slab. |
| When STT is applicable | 15% |
How capital gains is calculated?
The process of short term and long-term capital gains calculation is as below:
Short term capital gains = Full value consideration Less expenses incurred exclusively for such transfer Less cost of acquisition Less cost of improvement.
Long term capital gains = Full value consideration Less expenses incurred exclusively for such transfer Less indexed cost of acquisition Less indexed cost of improvement Less expenses that can be deducted from full value for consideration eg. Brokerage, cost of stamp paper, related travelling expenses, inheritance cost etc.
What is indexation?
Indexation is a process to adjust cost of acquisition with inflation. It is done by applying Cost Inflation Index (CII) which is announced by Central Government. Thereby, the cost base increase and gains lowers. The calculation method is as below:
Indexed cost of acquisition = (Cost of acquisition X CII in the year of transaction)/(CII in the year of acquisition)
The latest CII is as below
| Financial Year | CII | Financial Year | CII |
| 2001-02 (Base year) | 100 | 2012-13 | 200 |
| 2002-03 | 105 | 2013-14 | 220 |
| 2003-04 | 109 | 2014-15 | 240 |
| 2004-05 | 113 | 2015-16 | 254 |
| 2005-06 | 117 | 2016-17 | 264 |
| 2006-07 | 122 | 2017-18 | 272 |
| 2007-08 | 129 | 2018-19 | 280 |
| 2008-09 | 137 | 2019-20 | 289 |
| 2009-10 | 148 | 2020-21 | 301 |
| 2010-11 | 167 | 2021-22 | 317 |
| 2011-12 | 184 | 2022-23 | 331 |
Example,
John purchases an apartment in October 2004 for ₹25 lakh. He sells the apartment in January 2023 for a sum of ₹120 lakh. What will be the indexed cost of acquisition and capital gains?
By applying the above formula,
Indexed cost of acquisition = (Cost of acquisition X CII of FY 2022-23)/(CII of FY 2004-05)
= (25,00,000 X 331)/113
= 73,23,009
Therefore, the capital gains = 120,00,000 – 73,23,009 = 46,76,991/-
Applicable exemption for capital gains?
Tax is not applicable in case of following assets:
- inherited property
- Any stock, consumable or raw material, held for business
- Agricultural land in rural India
- 6½% gold bonds (1977) or 7% gold bonds (1980) or national defence gold bonds (1980) issued by the central government.
- Special bearer bonds (1991).
- Gold deposit bond issued under the gold deposit scheme (1999) or deposit certificates issued under the Gold Monetisation Scheme, 2015.
IT Act provide exemptions under section 54:
Under the section 54F , an income tax assessee can get an exemption from long term capital gains from the sale of house property by investing in up to two house properties against the earlier provision of one house property with same conditions. However, the gains on the sale of house property must not exceed Rs 2 crores.
The taxpayer has to invest the amount of gains and not the entire sale proceeds. If the purchase price of the new property is higher than the amount of gains, the exemption shall be limited to the total gains on sale.
Conditions for availing this benefit are
- The new property can be purchased either 1 year before the sale or 2 years after the sale of the property.
- The gains can also be invested in the construction of a property, but construction must be completed within three years from the date of sale.
- In the Budget for 2014-15, it has been clarified that only 1 house property can be purchased or constructed from the capital gains to claim this exemption.
- Please note that this exemption can be taken back if this new property is sold within 3 years of its purchase/completion of construction.
Under section 54EC, an assessee can also avail exemption when capital gains from sale of the first property are reinvested into specific bonds as below:
- issued by National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC) upto ₹50 lakhs
- The money invested can be redeemed after 5 years, but they cannot be sold before the lapse of 5 years from the date of sale.
- The homeowner has six month’s time to invest the profit in these bonds. But to be able to claim this exemption, you will have to invest before the tax filing deadline.
Under section 54B, there is exemption on sale of land used for agricultural purpose and also on compensation received on land acquisition even in urban area.
You may like to read Tax Planning.