If you buy something as an investment and later sell it at a higher price, the money you make is called a capital gain and the income tax you pay on it is capital gain tax.
The amount of tax depends on how long you hold the asset before selling it. If you hold the capital asset for over a year, you pay long-term capital gains tax. However, if you hold it for less than a year, you pay short-term capital gains tax on the profit you make.
What Is Capital Gain Tax?
Capital gain tax is levied on the profits realised from the sale or exchange of a capital asset. It applies to individuals, businesses, and other entities that engage in the sale of assets, such as stocks, bonds, real estate and other investments. The capital gain is calculated as the difference between the sale price of the asset and its original purchase price or on a price-adjusted basis.
There are two types of capital gains; short-term and long-term. Short-term capital gains (STCG) arise from the sale of assets held for one year or less, while long-term capital gains (LTCG) arise from the sale of assets held for more than one year.
What constitutes a ‘Transfer’ in the Income Tax Act?
As per the Income Tax Act, transfer, in case of a capital asset, includes the following;
1/ Sale, exchange or relinquishment of the asset
2/ Extinguishment of any rights related to a capital asset
3/ Compulsory acquisition of an asset
4/ Conversion of capital asset into Stock-in-Trade
5/ Maturity or redemption of a Zero Coupon Bond
6/ Possession of immovable properties to the buyer as part performance of a contract under the provisions of the Transfer of Property Act, 1882
7/ Any transaction leading to the transfer (or enabling the enjoyment of) of immovable property
8/ Disposing of or parting with an asset or any interest therein or creating any interest in any asset in any manner whatsoever
Note: These actions described under Section 2(47) of the Income Tax Act are considered transfers to determine tax liabilities under the income head ‘Capital Gains’.
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How Is Short Term Capital Gains Tax Calculated?
Here’s how you can calculate the taxable gains from the sale of short-term capital assets;
Step 1: Calculate STCG
To calculate short term capital gains, deduct the expenses incurred exclusively for the transfer (like brokerage charges), cost of acquisition and cost of improvement from the full value consideration. Here, full value consideration is the amount received for the transfer of the capital asset.
Step 2: Calculate STCG Tax
STCG tax is calculated based on the concessional rate of 15% under section 111A of the Income Tax Act. Section 111A applies to STCG from the purchase or sale of equity shares, units of equity-oriented mutual funds or units of business trust.
For this concessional rate to apply, the transaction must be conducted through a recognised stock exchange and be liable to securities transaction tax (STT). An exception is made for transactions undertaken on an International Financial Service Center (IFSC).
Step 3: Set Off
If you are an Indian resident whose total income is lower than the basic exemption limit, then you are entitled to set off your STCG against the losses from short term capital asset (STCAs). The remaining amount is then taxed at 15%. Non-residents are not entitled to claim the exemption limit and are required to pay tax at the flat rate of 15%.
Note: Any loss from STCAs can be carried forward for up to eight future years to offset against either future STCG or LTCG.
How Is LTCG Tax Calculated?
Here is how you can compute your long term gains from Long Term Capital Assets (LTCAs):
Step 1: Calculate LTCG
The calculation is the same as STCG, but in this case the cost of acquisition and improvement are indexed, to account for inflation.
Step 2: Calculate LTCG Tax
After calculating the LTCG, a 20% tax is levied on it. Any losses from LTCAs can be set off against your LTCG.
Suppose you sold a house for a total consideration of ₹10 lakh. The indexed cost of acquisition, after adjusting for inflation using the Cost Inflation Index, is ₹7 lakh. The indexed cost of improvement is ₹1 lakh. After deducting these indexed costs, LTCG is ₹2 lakh. You have also incurred a loss of ₹0.5 lakh on other LTCAs. So, now the LTCG tax payable is ₹30,000 (20% on 1.5 lakh).
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How Is The Capital Gains Tax Calculated In The New Tax Regime?
LTCG on sale of property or jewellery is taxed at 20% with an indexation benefit under the new tax regime. However, LTCG up to ₹1 lakh is exempt from tax. For debt mutual funds, capital gains will be taxed similar to interest earned on bank fixed deposits.
How Can I Save Taxes On Sale Of Property?
You can save taxes on the sale of residential property, in the following ways:
1/ You can reinvest the sale proceeds in a new residential property within 2 years to avail capital gains tax exemption under section 54 of the Income Tax Act.
2/ You can also invest the capital gains in specified bonds under section 54EC to defer the tax liability for up to 3 years.
3/ You could claim an exemption under section 54F if you use the sale proceeds to purchase or construct a new residential property.
4/ Or you could adjust the cost of acquisition by indexation, offsetting capital gains with capital losses and timing the sale to minimise your tax liability.
Is The Benefit Of Indexation Available While Computing Capital Gain On The Transfer Of Short-Term Capital Assets?
The benefit of indexation is not available while computing capital gain on the transfer of short-term capital assets. As per the Income Tax Act, indexation is only applicable for long-term capital assets. For short-term capital gains, the tax is calculated on the actual sale price without any indexation benefit.
How Do You Set Off Capital Loss Against Capital Gains?
Here’s an example of how tax loss harvesting works.
Ritika is an investor, who has incurred short-term capital losses of ₹50,000 from the sale of equity stocks during this financial year. During the same year, she had a long-term capital gain of ₹70,000 from the sale of mutual fund units. In this case, she can set off her short-term capital losses of ₹50,000 against her long-term capital gains of ₹70,000. As a result, Ritika’s net capital gains would be ₹20,000.
To set off capital losses against capital gains, you can opt for tax harvesting. Short-term capital losses can be set off against short-term and long-term capital gains, while long-term capital losses can only be set off against long-term. Any remaining capital losses after setting off against gains can be carried forward to eight succeeding years from the year the loss has incurred.
Tax loss harvesting involves selling investments at a loss to offset gains. It is a strategy to minimise tax liability. This strategy aims to maximise the offset of capital losses against capital gains to reduce your tax burden.
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