Capital Gains and Taxes: A Complete Guide

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By Hiral Vakil on March 8, 2019

Definition of Capital Gain

Capital Gain is simply the profit or gain that arises when you sell a Capital Asset. If you sell a Long Term Capital Asset, you will have Long Term Capital Gain and if you sell a Short Term Capital Asset, you will have a Short Term Capital Gain. If the result from sell is negative, you will have a capital loss. The Capital Gain will be chargeable to tax in the year in which the transfer of Capital Asset takes place.

What is a Capital Asset?

Capital Asset means any kind of property owned by you, whether or not connected with your business or profession. It includes movable assets, immovable assets, tangible/intangible assets, rights and choices in actions, etc.

Some of the examples of Capital Assets are House Property, land, building, goodwill, patent, trademark, rights, machinery, vehicles, jewelry, etc.

However, the following assets shall not be considered as Capital Assets:

  • ​Any stock in trade, consumables or raw material held for the purpose of business or profession.
  • ​Any personal effects like clothes or furniture etc. Which is held for your personal use.
  • Agricultural land which is not situated within:
    • the jurisdiction of municipality or cantonment board which has a population between 10,000 and 1,00,000.
    • 6 KMs of municipality or cantonment board which has a population between 1,00,000 and 10,00,000.
    • 8 KMs of municipality or cantonment board which has a population of more than 10,00,000.
  • Gold Bonds, Special Bearer Bonds & Gold Deposit Bonds issued by Government of India.

What is ‘Long Term’ and ‘Short Term’ Capital Asset?

If a Capital Asset is held by the assessee for more than 36 months prior to its sale, then it is a Long Term Capital Asset. On the other hand, Short Term Capital Asset means the asset held by an assessee for not more than 36 months prior to its sale.

However, in the following cases, the assets will be considered Short Term if they are held for 12 months or less instead of 36 months:

  • ​Equity or Preference shares.
  • ​Debentures or Government securities.
  • Units of UTI.
  • Units of equity oriented mutual fund.
  • Zero coupon bonds.

If the above mentioned assets are held for more than 12 months, they will be considered as Long Term Capital Assets.

Note: Determination of period of holding is important because it impacts the method of calculating Capital Gains and also the tax rates.

How to determine the holding period if asset was gifted?

In case the asset was acquired as a gift, or through a will, succession or inheritance, the period of holding by previous owner will also be included to determine the total holding period.

For eg., A gifted a watch to B on 01/12/2015. This watch was acquired by A on 01/12/2013. So for B, total period of holding the watch will be from 01/12/2013 till the sale of the watch.

In case of bonus shares or right shares, the period of holding will be calculated from the date they were allotted.

Calculate the Capital Gains

Calculation of Capital Gains is different in case of Long Term Capital Assets and Short Term Capital Assets. Here are some of the terms you need to know:

Full Value of Consideration: It is the amount received or to be received by the seller when he sells (transfers) the asset to the buyer. Capital Gain will be chargeable in the year in which the asset is transferred, even though consideration is received later on.

Cost of Acquisition: It is the purchase price at which the seller acquired the asset.

Cost of Improvement: It is an expense that is incurred to make any improvements or repairs or enhancements to the asset. Improvement costs will be considered only if they are incurred after 1st April 1981.

Indexation: It is derived with the help of Cost Inflation Index. Cost Inflation Index is simply the measure of inflation and it is notified by the Central Government every year. Indexation is a technique to adjust income/payments by means of a price Index, in order to maintain the purchasing power of the public due to inflation. Here is the Cost Inflation Index over the years.

Cost Inflation Index Calculator
Here is the Cost Inflation Index over the years.

How to Calculate Short Term Capital Gains?

ParticularsAmount
Take full value of ConsiderationXXXX
Less:​
Expenditure incurred exclusively in connection with the transfer.​​
Cost of Acquisition.
​Cost of Improvement.

​(XXX)

​​(XXX)​
(XXX)
Less: exemption under section 54B
(XXX)
Short Term Capital Gain (1-2-3)
XXXX

How to Calculate Long Term Capital Gains?

ParticularsAmount
Take full value of ConsiderationXXXX
Less:​
Expenditure incurred exclusively in connection with the transfer.
​​Index* Cost of Acquisition.
Index* Cost of Improvement.

(XXX)
​​
(XXX)
​(XXX)
Less: exemption under section 54, 54EC, 54F, 54B
(XXX)
Long Term Capital Gain
XXXX
Indexed cost of Acquisition Calculator
Here is the Cost Inflation Index over the years.

Can I claim any expenses as a deduction from the full value of consideration?

Expenses which are wholly and exclusively incurred in relation to the transfer of property, are allowed to be deducted from sales consideration. So here are different sales transactions and the allowable expenses for the same:

Sale of shares/stocks:

  • ​Brokerage or sales commission.
  • ​Please note that Securities Transaction Tax (STT) is not allowed as deduction.

Sale of House Property:

  • ​Commission or brokerage paid to the property agent.
  • ​Stamp duty paid on transfer of property.
  • ​Any travelling expenditure incurred in order to complete the sales transaction may be allowed as deduction.
  • ​In case the property is transferred as a result of inheritance, any legal charges related to obtaining succession certificate, executor fees etc., may also be allowed as deduction.
  • ​In case of compulsory acquisition, litigation expenses for claiming the enhanced compensation is allowed as deduction.

All these expenses are allowed as deduction only for the purpose of calculating the Capital Gains. Please note that these expenses are not allowed as a deduction from any other heads of income.

Cost of acquisition and cost of improvement are also allowed as a deduction from the sales consideration.

Indexed cost of Acquisition Calculator
Here is the Cost Inflation Index over the years.

What are the tax rates for Short Term and Long Term Capital Gains?

Type of Capital GainTax Rate
Long Term Capital Gain (when Securities Transaction Tax is not applicable)20% + Surcharge and Education Cess
Long Term Capital Gain (when Securities Transaction Tax is applicable)Exempt
Short Term Capital Gain (when Securities Transaction Tax is not applicable)Normal slab rate applicable to Individuals
Short Term Capital Gain (when Securities Transaction Tax is applicable)15% + Surcharge and Education Cess

Taxability of gains from the sale of Equity and Debt mutual funds are different. Funds with more than 65% of the portfolio consisting of equities are called Equity Funds.

Short Term Capital GainLong Term Capital Gain
Debt FundsNormal slab rate applicable to Individuals20% with Indexation + Surcharge and Education Cess
Equity Funds15% + Surcharge and Education cessExempt

Note: Unlike Equity mutual funds, debt funds have to be held for more than 36 months to qualify as Long Term Capital Assets.

What are the Exemptions available on Capital Gains?

The Income Tax Act allows a total / partial exemption from Capital Gains under different sections. It is possible to avail of multiple exemptions under these sections. However, the aggregate amount of exemption cannot exceed the total amount of Capital Gain.

Let’s have a look at all the available exemptions one by one:

Exemption under Section 54B on transfer of land used for agricultural purpose

This exemption is available when:

  • ​A Long Term or Short Term land which was used for agricultural purpose is sold.
  • ​Out of the sale proceedings, another agricultural land is bought within 2 years from the sale of the first agricultural land.
  • Such new agricultural land may be in a rural area or urban area.
  • The new land should not be sold within 3 years from the date of its purchase.

Amount of Exemption under Section 54 will be lower of amount invested in new agricultural land or the Capital Gain.

If you are unable to utilize the whole or part of the sales consideration for the purchase of new agricultural land till the due date of submission of ITR, then it should be deposited in “Capital Gains Deposit Account Scheme”.

Exemption under Section 54 on sale of a House Property and on purchase of another House Property

This exemption is available when:

  • ​A Long Term residential House Property has been sold.
  • ​A new residential house is purchased before one year or after two years from the sale of the residential House Property, or
  • In case of construction of a new House Property, within three years from the sale of the residential House Property.
  • The new residential House Property should not be sold until 3 years from the date of its purchase.

Amount of Exemption under Section 54 will be lower of amount invested in new residential House Property or the Capital Gain.

If you are unable to utilize the whole or part of the sales consideration for purchase/construction of new property till the due date of submission of ITR, then it should be deposited in “Capital Gains Deposit Account Scheme”.

Exemption under Section 54F on sale of any assets other than House Property

This exemption is available when:

  • ​Any Long Term Capital Asset (Other than a residential House Property) has been sold.
  • ​On the date of the sales, you do not own more than one residential House Property (Except for the new house you are going to buy/construct).
  • On the date of the sales, you do not own more than one residential House Property (Except for the new house you are going to buy/construct).
  • In case of construction of a new House Property, within three years from the sale of the long term Capital Asset.

Amount of Exemption under Section 54F will be available as per the following formula:

Investment in the new asset x (Capital Gain / Net sales consideration)

The benefit of the Capital Gains Deposit Account Scheme is available.

Exemption under Section 54EC on Sale of any Long Term Capital Asset and Reinvestment in Bonds of REC/NHAI

This exemption is available when:

Amount of Exemption under Section 54EC will be lower than the amount invested in bonds or the Capital Gain.

  • ​Any Long Term Capital Asset has been sold.
  • ​Bonds of National Highway Authority of India (NHAI) or Rural Electrification Board (REC) have been purchased for up to Rs. 50 Lakhs (maximum allowable) within six months from the sale of the Long Term Capital Asset but before the due date for e-filing the tax return.
  • Amount invested can be redeemed after 3 years but cannot be sold before the lock-in period of 3 years from the date of sale of an asset.