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Capital Gains – Types, Calculation and Tax Exemption on Capital Gains
Capital gain is denoted as the net profit that an investor makes after selling a capital asset exceeding the price of purchase. The entire value earned from selling a capital asset is considered as taxable income. To be eligible for taxation during a financial year, the transfer of a capital asset should take place in the previous fiscal year.
Financial gains against a sale of an asset are not applicable to inherited property. It is considered only in case of transfer of ownership. According to The Income Tax Act, assets received as gifts or by inheritance are exempted in the calculation of income for an individual.
Buildings, lands, houses, vehicles, Mutual Funds, and jewelry are a few examples of capital assets. Also, the rights of management or legal rights over any company can be considered as capital assets.
The following are not included under capital assets –
- Any stock, consumables or raw materials that are held for the purpose of business or profession.
- Goods such as clothes or furniture that are held for personal use.
- Land for agriculture in any part of rural India.
- Special bearer bonds that were issued in 1991.
- Gold bonuses issued by the Central Government such as the 6.5% gold bonus of 1977, 7% gold bonus of 1980 and defense gold bonus of 1980.
- Gold deposit bonds that were issued under the gold deposit scheme (1999) or the deposit certificates that were issued under the Gold Monetisation Scheme (2015).
Types of Capital Gain
Depending on the tenure of holding an asset, gains against an investment can be broadly divided into the following types –
- Short term capital gain
If an asset is sold within 36 months of acquisition, then the profits earned from it is known as short term capital gains. For instance, if a property is sold within 27 months of purchase, it will come under short term capital gains.
However, tenure varies in the case of different assets. For Mutual Funds and listed shares, Long term capital gain happens if an asset is sold after holding back for 1 year.
- Long term capital gain
The profit earned by selling an asset that is in holding for more than 36 months is known as long-term capital gains. After 31st March 2017, a holding period for non-moveable properties was changed to 24 months. However, it is not applicable in case of movable assets such as jewelry, debt-oriented Mutual Funds, etc.
Furthermore, a few assets are considered as short-term capital assets if the holding period is less than 12 months. Here is a list of assets that are considered according to the rule mentioned above –
- Equity shares of any organization listed on a recognized Indian stock exchange.
- Securities like bonds, debentures, etc. that are listed on any Indian stock exchange.
- UTI units, regardless of being quoted or unquoted.
- Capital gain on Mutual Funds that are equity-oriented, whether they are quoted or not.
- Zero-coupon bonds.
All the assets mentioned above are considered as long-term capital assets if they are held for 12 months or more. In case of any asset acquired by inheritance or gift, then the period for which an asset is owned by a previous owner is considered. Furthermore, in the case of bonus shares or right shares, the period of holding is considered from the date of allotment.
Here is a duration chart on an income generated against the sale of assets –
|Type of asset||Short term duration||Long term duration|
|Immovable assets (e.g. real estate)||Less than 2 years||More than 2 years|
|Moveable property(e.g. Gold)||Less than 3 years||More than 3 years|
|Listed Shares||Less than 1 year||More than 1 year|
|Equity Oriented Mutual Funds||Less than 1 year||More than 1 year|
|Debt Oriented Mutual Funds||Less than 3 years||More than 3 years|
Calculation of Capital Gains
The calculations of capital gains are dependent on the type of assets and their holding period. A few terms that an individual must know before calculating gains against their capital investments are here as follows –
- Full value consideration –
It is the consideration that is received by a seller in return for a capital asset.
- Cost of acquisition –
The cost of acquisition is the value of an asset when a seller acquires it.
- Cost of improvement –
The cost of improvement is the amount of expenses incurred by a seller in making any additions or alterations to a capital asset.
To calculate the value of short term capital gain, the full amount of consideration is required to be determined at first. From the obtained value, cost of acquisition, cost of improvement and the total expenditure incurred concerning the transfer of ownership has to be deducted. This resultant value will be the capital gain on investments.
Indexed Cost of Acquisition
The cost of acquisition is calculated on the present terms by applying the CII (Cost Inflation Index). It is done to adjust the values by taking into account the inflation that takes place over the years while holding the asset.
The indexed cost of acquisition can be estimated as the ratio of the Cost Inflation Index (CII) of the year when an asset was sold by a seller and that of the year when the property was acquired or the financial year 2001-2002, whichever is later multiplied by the Cost of acquisition.
Suppose, a person acquired an asset at Rs. 50 Lakh in the financial year 2004-2005 and she decided to transfer the property in the fiscal year 2018-19. The CII of the financial year 2004-05 and 2018-19 were 113 and 280 respectively.
Therefore, the indexed cost of acquisition will be 50 X 280 / 113 = Rs. 123.89 Lakh.
Indexed Cost of Improvement
The indexed cost of the improvement is calculated by multiplying the associated cost of improvement that was required to the CII of the year divided by the CII of the year in which the improvement took place.
Tax Exemptions on Capital Gains
Tax exemptions can be claimed under the following sections on the profit earned against assets –
1. Section 54 –
If an amount earned by selling a residential property is invested to purchase another property, then the capital gains earned by transferring the ownership of a property is tax exempted. However, deductions can be claimed only if the following conditions are met –
- Individuals are required to purchase a second property within 2 years of sale or 1 year before transferring the ownership.
- In the case of an under-construction property, the purchase of a second property should be completed within 3 years of transferring the ownership of the first property.
- Newly acquired property cannot be sold within 3 years of purchase.
- The newly acquired property is required to be located in India.
2. Section 54F –
Exemptions under Section 54F can be claimed when there are capital gains earned from a long-term asset other than a residential property. However, the exemption stands invalid if you sell the new asset within 3 years after purchasing or construction.
The purchase of a new property should be made within 2 years of earning the capital. Also, in the case of construction, it has to be completed within 3 years from the date of sale.
3. Section 54EC –
Individuals can claim tax exemptions under Section 54EC if the capital gains statements are submitted for investments into specific bonds with the amount earned by selling a property.
The invested amount can be redeemed after 3 years from the date of sale, but the bonds cannot be sold within the period. This period has been increased to 5 years with effect from the financial year 2018-19. Individuals are required to invest in these special bonds within 6 months of a property sale.
Earing capital gains is much convenient with various beneficial investment options in the market. Also, if reinvested correctly, tax incurred on capital gains can be reduced ensuring higher savings.