What are Capital Gains: Calculation, Tax Exemption and Types
Individuals make investments in mutual funds and purchase various capital assets. Capital gains arise when they sell the mutual fund units and other capital assets. Keep reading to know more!
What are Capital Gains?
Capital gains are the net profits that investors earn after selling their capital assets at a price higher than the cost of acquisition. The earnings from the sale of capital assets will be taxable. To qualify for taxation in a fiscal year, the capital asset transfer must take place during the last financial year.
A financial gain through the sale of a capital asset isn’t applicable to an inherited property. As per the IT Act, 1961, assets by way of inheritance or gifts are exempted in income computation for a taxpayer.
Capital assets can be jewellery, vehicles, houses, lands, and buildings. Besides, legal rights or management rights over an entity will be eligible as capital assets.
Capital assets do not include the following:
- Gold deposit bonds that were issued under the Gold Deposit Scheme, 1999
- Deposit certificates that were issued under the Gold Monetisation Scheme, 2015
- Gold bonuses that the Central Government has issued such as defence gold bonus (1980), a 7% gold bonus (1980) and a 6.5% gold bonus (1977)
- Special bearer bonds (1991)
- Agricultural land in the rural parts of India
- Commodities for personal use, such as furniture or clothes
- Any raw materials, consumables or stock held for professional or business purposes.
Types of Capital Gains
Based on the holding period of a particular asset, capital gains can be categorised in the following ways:
1. Short-term Capital Gains
In case a capital asset has been sold within 3 years of acquisition, then profits applicable from it are called short-term capital gains (STCG). For example, if the holding period of a property is 26 months, then profits from its sale will fall under short-term capital gains.
However, duration differs from asset to asset. In the case of listed shares and equity-oriented mutual funds, short-term gain on capital arise if an individual sells the asset before holding it for one year.
2. Long-term Capital Gains
The profits applicable after selling a capital asset that has been held for above 3 years are called long-term capital gains (LTCG). Post March 31 2017, the holding period in the case of non-movable capital assets was set at 2 years. However, movable capital assets such as debt-based mutual fund units and jewellery do not qualify for the updated holding period.
Certain assets come under the category of short-term capital assets in case they are held for below 1 year. Here are some examples:
- Zero-coupon bonds
- Capital gains on equity-based mutual funds, whether they’re unquoted or quoted
- UTI units, irrespective of being unquoted or quoted
- Securities such as debentures and bonds that have been listed on a stock exchange
- Equity shares of a company listed on a stock exchange
The above-mentioned assets come under the category of long-term capital assets in case the holding period is 1 year or above. If an individual acquires an asset by way of a gift or inheritance, then the tenure for which the previous owner has owned the asset will be applicable. Besides, for right shares or bonus shares, the allotment date determines the holding period.
Go through the duration chart below to better understand the concept:
| Kind of Asset | Long-Term Duration | Short-Term Duration |
| Debt-based mutual funds | Above 3 years | Below 3 years |
| Equity-based mutual funds | Above 1 year | Below 1 year |
| Listed shares | Above 1 year | Below 1 year |
| Movable property (such as gold) | Above 3 years | Below 3 years |
| Immovable assets (such as real estate) | Above 2 years | Below 2 years |
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Taxation of Capital Gains
The following chart will guide you through the capital gains tax levied on different assets in India:
| Tax Type | Prescribed Condition | Tax Payable |
| STCG | Securities transaction tax (STT) is applicable | 15% |
| STCG | STT isn’t applicable | STCG is added to your income, and you’ll be taxed as per your income tax bracket. |
| LTCG | Selling units of equity-based mutual funds/equity shares | 10% over and above Rs. 1,00,000 |
| LTCG | Sale of capital assets, excluding equity-based mutual fund units/equity shares | 20% |
How to Calculate Capital Gains?
The following is a brief explanation of how one can calculate gains on capital:
1. Short-Term Capital Gains
In order to calculate the short-term gains, one must use the following formula:
Short-term capital gain = full value consideration – (cost of acquisition + cost of transfer + cost of improvement)
2. Long-Term Capital Gains
Individuals need to use the following formula to calculate long-term gains tax:
Long-term capital gain = full value of the consideration received or accruing – (indexed cost of improvement + indexed cost of acquisition + cost of transfer)
Given below is a description of the various terms used to calculate gains on capital:
As per the following sections, an individual can claim tax exemption on the capital earned from different assets:
- Indexed cost of acquisition = cost of acquisition x cost inflation index of the year of transfer/cost inflation index of the year of acquisition.
- Indexed cost of improvement = cost of improvement x cost inflation index of the year of transfer/cost inflation index of the year of improvement.
- Cost Inflation Index (CII): CII refers to an index that the government declares every year, and it remains fixed throughout the year. This index is used to adjust for the effects of inflation on goods and services.
This calculation can be explained through the following example:
Mr. Ray purchased an apartment for Rs.10 lakh in 2005. After 10 years, he sold the apartment for Rs. 30 lakh.
The CII= Index for FY 2014-15/Index for FY 2005-2006 = 1024/480 = 2.13
Indexed cost of purchase = CII x Purchase Price = 2.13 x 10,00,000 = 21,30,000
Long-term capital gain = Selling Price – Indexed cost = 30,00,000 – 21,30,000 = Rs.8,70,000
Tax on capital gain = 20% of 8,70,000 = Rs. 1,74,000
Tax Exemptions for Capital Gains
1. Section 54EC
Often, a taxpayer submits his/her gain on capital statement for investments towards certain bonds. In this case, the income has been earned through the sale of a property. As per Section 54EC, taxpayers can claim tax exemption for such capital gains.
2. Section 54F
When an individual fetches capital gains through the sale of long-term assets (except for residential property), tax exemptions are applicable under Section 54F. However, such an exemption becomes invalid in case a taxpayer sells this new capital asset within three years post-construction or purchase.
Note that an individual should buy a new property within 24 months of earning capital gains. Further, if individuals construct a house, it should be finished within 36 months from the day of sale.
3. Section 54
Many times, a taxpayer invests an income from the sale of a residential property to buy another property. The capital gains earned through this ownership transfer are tax-exempt. However, deductions will be applicable after satisfying the following conditions:
- The new property should be in India.
- An individual cannot sell this new property within 36 months of purchase.
- If a property is under construction, then an individual should buy a second property within 36 months of the first property’s ownership transfer.
- An individual should buy the second property within 24 months of sale or one year prior to ownership transfer.
Final Word
With various beneficial investment avenues in the Indian market, fetching capital gains is easy. If an individual reinvests such profits correctly, tax exemptions will be available, ensuring more savings.
FAQs
Ans: The assets’ holding period and the type determine the computations of capital gains. The acquisition cost is an asset’s value when a seller purchases it, and it is essential for estimating gains on capital.
Ans: Yes, calculations of capital gains involve an asset’s full value of consideration and its improvement cost. Full value consideration is an amount that a seller receives in exchange for an asset. The improvement cost refers to those expenses that a seller incurs for making any alterations or additions to an asset.
Ans: An individual can estimate his/her STCG in the following way:
Short-term capital gains = Full value of consideration – Improvement cost – Total expenses incurred at the time of ownership transfer – Cost of acquisition
Ans: The acquisition cost is the purchase price of a property. An individual can calculate the acquisition cost considering the current inflation rate by taking into account the Cost Inflation Index (CII). This is called an indexed acquisition cost. Indexation denotes making adjustments to the values by considering the inflation factor over the time period for which an asset was held.
Ans: An individual can compute his/her LTCG in the following way:
Long-term Capital Gains = Full value of consideration accruing or received – (Cost of transfer + Indexed improvement cost + Indexed acquisition cost)
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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