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Capital Gains Tax

The term capital gains can be defined as profits accumulated from the sale of any capital asset. Such gains can be accrued either through the sale of investment or real estate property.

Depending on the duration, capital gains can either be short-term or long-term. Since profits are categorised as an ‘income’, they are liable for taxation, which is known as capital gains tax.

What is a Capital Gain Tax?

The tax that is levied on capital gains is termed as capital gain tax. Such taxes are levied when an asset is transferred between owners. Though all capital gains are liable for taxation, the tax approach for long-term gains tend to differ from that of short-term gain. Taxpaying individuals can use tax-efficient financial strategies to reduce the burden of their capital gains taxes.

Here is an example of how it works –

Mr. B purchased a house for Rs. 50 Lakh in July 2004. The full value of consideration in the financial year of 2016-2017 stood at Rs. 1.8 Crore. The said property was held for over 36 months and was, therefore, deemed as a long-term capital asset.

After taking into consideration the inflation, the cost price was adjusted, and the indexed cost of acquisition was also taken into account.

The adjusted cost of the property was then settled at Rs. 1.17 Crore, which means Mr. B accrued a net capital gain worth Rs. 63 Lakh. After a long-term capital gains tax rate of 20% was levied on the net capital gain, the tax liability that was to be paid by Mr. B arrived at a total of Rs. 12,97,800.

Types of Capital Gains Taxation

There are two types of capital gains –

  1. Short-term capital gain tax – Any asset that is held for less than 36 months is termed as a short-term asset. In the case of immovable properties, the duration is 24 months. The profits generated through the sale of such an asset would be treated as short-term capital gain and would be taxed accordingly.
  2. Long-term capital gain tax – Any asset that is held for over 36 months is termed as a long-term asset. The profits generated through the sale of such an asset would be treated as long-term capital gain and would attract tax accordingly.

Assets like preference shares, equities, UTI units, securities, equity-based Mutual Funds and zero-coupon bonds are also considered as long-term capital asset if they are held for over a year.

Regulations on Short-Term Gains and Long-Term Gains Taxation

Under Section 80C of Income Tax Act –

The short-term capital gains would attract a tax at the rate of 15% of the investor decides to sell it within a year.

A long-term Mutual Funds capital gains tax would be charged at a rate of 10% on profits exceeding Rs. 1 Lakh generated through equity-oriented funds and shares.

The table mentioned below shows how the short-term and long-term capital gains taxation in India is calculated.

For long-term capital gains –

Tax Type Circumstance Rate of tax
Long-term capital gains Tax In the case of sale except for equity-oriented funds or shares. 20% without adjusting for indexation.
Long-term capital gains Tax In the case of sale of equity-oriented funds or shares. Over 10% on and above Rs. 1 Lakh.

For short-term capital gains –

Short-term capital gains Tax In the case when the securities transaction tax is not liable. The short-term gain is added to the income tax returns and taxed accordingly.
Short-term capital gains Tax In the case when securities transaction tax is liable. 15%

Treatment of equity and Mutual Funds capital gains tax 

Any gains accrued on the sale of equity funds and debt Mutual Funds are treated differently.

Check the tables below to find out the differences in their calculation –

Table 1 – Effective till 10th July 2014

Funds Short-term Gains Long-term Gains
Equity Funds 15% Nil
Debt Funds As per the income tax slab. 20% with indexation or 10% without indexation (which of the two is lower).

Table 2 – Effective from 11 July 2014

Funds Short-term Gains Long-term Gains
Equity Funds 15% Nil
Debt Funds As per the income tax slab. 20% with indexation.

Exemption on Capital Gains Tax in India

Individuals can lower the burden of such taxes by availing the tax benefits offered by Income Tax Act of India. Such benefits can be availed when proceeds from the sale of one asset are reinvested into another asset.

Here are a few exemptions that individuals can avail to lower their burden of capital gains tax in India. 

  • Section 54 – States exemptions on gains incurred through the sale of an existing residential property and reinvesting the proceeds to purchase another residential property.

As per 2019 budget, individuals would be able to avail an exemption on their long-term capital gains amassed through sale of a residential property. They can do so by investing the sale proceeds into a maximum of two residential properties. In this case, capital gains accumulated should not be more than Rs. 2 Crore.

In case the cost of the new property is lower than that of the sold unit, the deduction would be liable to attract taxes in accordance to the Income Tax Act of India. But such an exemption can be availed only once by a tax-paying individual.

  • Section 54F – States exemptions on gains incurred through the sale of any asset besides a residential property.

Individuals can avail this benefit when capital gains have been accrued through the sale of a long-term asset that is not a residential property.

To avail such an exemption, individuals have to reinvest their sale consideration (inclusive of capital gains) to purchase a new property. Such a purchase should be made 12 months before the sale or at least 24 months post sale.

  • Section 54EC – States exemptions on gains incurred through sale of an existing residential property and reinvesting its proceeds in particular bonds.

Individuals can avail exemptions under the said Section when they reinvest the proceeds earned through the sale of the first property into specific bonds within six months.

The funds invested in such bonds can be redeemed only after 60 months.

  • Section B – States exemptions on capital gains incurred through the transfer of land for agricultural purposes.

Individuals can avail exemption under the said section on the short-term or long-term capital gains accrued through the transfer of agricultural lands. The transfer of property has to be 24 months before the sale of the said asset. The exempted amount must be reinvested to purchase a new asset within 36 months from the date of such transfer.

Additionally, the property that is to be bought with the proceeds should not be sold within 36 months of acquisition.

There are several conditions which must be fulfilled to avail these capital gains tax benefits. Individuals must find out which tax benefit is applicable to them and whether they fulfil the pre-required conditions before applying as well. Being aware of such exemptions and how they function under different situation would help individuals reap the best returns.

However, individuals above the age of 60 years and with a minimum annual income of Rs. 3 Lakh are exempted from capital gains tax on their long-term capital gains.

Capital gains tax strategies to reduce the tax burden

The reason why every tax-paying individual wants to reduce the burden of capital gains tax is that they tend to erode a big portion of their capital earnings.

Individuals have an option to reduce their tax liability by adopting these following strategies.

  1. Holding assets longer: One of the simplest strategies to reduce the tax burden is by holding on to the assets for a longer period.

Individuals can reduce their tax liability to a significant extent by holding onto their assets for over 12 months before selling. The fact that the capital gain tax on long-term capital gains is lower than that of short-term capital gains will act in their favour.

  • Reinvest proceeds: Individuals can reduce their liability of capital gains tax on property by reinvesting the profits into a new asset within a stipulated time. Individuals need to be careful about the terms and conditions that are associated with such a strategic investment option to maximise their benefit and minimise the tax burden. Individuals can further lower their tax liability on their capital gains by reinvesting them for constructing a new property or investing them into capital gain bonds.
  • Invest in Capital Gain Account scheme: As a strategic move to reduce the capital gains tax, individuals can park their earnings into a capital gains account. This strategy can be adopted at times when they fail to invest in a new residential property within the stipulated time to save on their tax liability.

Besides these, several tax-saving strategies can be adopted by individuals to lower their capital gains tax in India.

Having a thorough knowledge about such taxes, their exemptions and associated terms and conditions come in handy while availing for a tax exemption on capital gains.

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