A Complete Guide to Capital Gains Tax in India

A Complete Guide to Capital Gains Tax in India

In India, when a person sells assets like shares, mutual funds, property, gold, or bonds for a profit, that profit is known as a capital gain. The government charges a tax on this profit, which is called the capital gains tax.

Let’s understand the term ‘capital gains’ in more detail:

What do you understand by capital gains and capital assets?

Capital Gains Tax: It is the tax you pay on the profit you make when you sell something valuable. For example, if you buy a house, gold, or shares at a lower price and later sell them at a higher price, the extra money you earn is called a capital gain. The government taxes this profit.

Capital Assets: These are the valuable things you own, such as property, shares, mutual funds, gold, jewellery, or even certain rights like patents or trademarks. When you sell any of these and make a profit, that profit is taxed as capital gains.

What are not Capital Assets?

You can think of “not capital assets” as items that are excluded from capital gains taxation. In simpler terms, these are things the law does not treat as investments for capital gain purposes. The following is on the list:

Business-related stock or materials: Items like stock-in-trade, raw materials, or consumables used in business

Personal-use items: Things meant for personal use, like clothes or household furniture, aren’t treated as capital assets.

Rural agricultural land in India: Land located in rural areas is excluded because it’s tied to agriculture, not investment activity.

Certain government gold bonds: Old gold bonds issued by the government (like 6½% Gold Bonds 1977, 7% Gold Bonds 1980, etc.) are specifically exempt.

Special Bearer Bonds (1991): These were issued under a special scheme and are not treated as capital assets.

Gold deposit-related certificates: Gold Deposit Bonds (1999) and certificates under Gold Monetisation Schemes (2015, 2019) are also excluded.

Classification of Capital Assets

Capital assets are divided into short-term and long-term based on how long you hold them before selling.

Listed shares & equity mutual funds:

• Held up to 12 months: Short-term
• Held more than 12 months: Long-term

Other assets (property, gold, unlisted shares, etc.):

• Held up to 24 months: Short-term
• Held more than 24 months: Long-term.

Long-term and short-term capital gains

Capital gains are generally classified based on how long an asset is held. If held for a longer period, the gain is treated as long-term, and if held for a shorter period, it is treated as short-term.

However, there are certain exceptions where the holding period does not matter. In such cases, even if the asset is held for a long time, the gain is still treated as short-term. This mainly applies to assets like depreciable business assets, such as machinery or commercial buildings and market-linked debentures.

Capital Gains Tax Rates In India

Capital gains tax depends on how long you hold an asset before selling it:

Tax Rates on Equity and Debt Mutual Funds

An equity mutual fund invests at least 65% of its assets in equities. If you sell equity mutual fund units within a short period, the profit is called Short-Term Capital Gain (STCG) and is taxed at 20%. If you hold the investment for more than 12 months, the profit becomes Long-Term Capital Gain (LTCG) and is taxed at 12.5%, but only the gains above Rs 1.25 lakh in a financial year are taxed; gains up to that limit are exempt.

Capital Gains Exemptions

Capital gains tax can become quite high when you sell assets such as property, land, or investments. However, the Income Tax Act provides multiple exemptions under Sections 54 to 54F and 54EC, which can reduce or eliminate tax if certain conditions are met. The following are the exemptions:

1. Section 54: Exemption on Sale of House Property

If you sell a residential house and earn long-term capital gains, you can avoid tax if you reinvest in another house.

• Exemption is available up to Rs 10 crore
• You must purchase or construct one new house
• You can also buy two houses, but only if capital gains do not exceed Rs 2 crore
• Investment must be made within a specified time period after the sale

2. Section 54F: Exemption on Sale of Any Asset (Except House)

If you sell any long-term asset other than a house, you can claim an exemption by buying a house.

• It applies to long-term capital gains only
• A new house can be purchased 1 year before the sale, or 2 years after the sale, or you can construct a house within 3 years
• Exemption is calculated as:
  Capital Gain × Cost of New House / Net Sale Value

3. Section 54EC: Exemption by Investing in Bonds

You can save tax by investing capital gains into certain government-approved bonds. The following are the eligible bonds:

• National Highway Authority of India (NHAI),
• Rural Electrification Corporation (REC),
• Power Finance Corporation (PFC) or
• Indian Railway Finance Corporation (IRFC)

Investment must be made within 6 months of sale. Lock-in period is 5 years. Bonds cannot be sold for 5 years.

4. Section 54B: Sale of Agricultural Land

If you sell agricultural land and reinvest in another agricultural land, you can get an exemption.

• It applies to both short-term and long-term gains
• You must buy new agricultural land within 2 years
• The new land must not be sold within 3 years
• Exemption is the lower of Capital gain or the amount invested

5. Capital Gains Account Scheme (CGAS)

If you cannot invest before the tax return deadline. Deposit the capital gains in a Capital Gains Account in a PSU bank. This will allow you to still claim the exemption. If not used within the time limit, it becomes taxable in the year it expires

How Capital Gains Are Calculated

Capital gains depend on how long you hold the asset.

Key Terms
1. Full Value of Consideration

• The total amount received or expected from selling the asset
• Tax is charged even if payment is not fully received

2. Cost of Acquisition

• The price paid to buy the asset originally

3. Cost of Improvement

• Expenses spent on improving or upgrading the asset.

How Short-Term Capital Gains are Calculated

1. Begin with the full value of consideration

2. Deduct the following things:

• Expenditure incurred wholly and exclusively for such transfer
• Cost of acquisition
•  Cost of improvement

3. From this resulting number, deduct exemptions provided under sections 54B/54D.

4. This amount is a short-term capital gain to be taxed

How Long-Term Capital Gains are Calculated

1. Start with the full value of consideration

2. Deduct the following:

• Expenditure incurred wholly and exclusively in connection with such transfer
• Indexed cost of acquisition
• Indexed cost of improvement

3. From this resulting number, deduct exemptions provided under sections 54, 54D, 54EC, 54F and 54B.

Deductible Expenses

A. Sale of house property

When you sell a house, you can subtract certain costs from the selling price before calculating profit (capital gains), such as the following:

• Money paid to a broker or agent to find a buyer
• Stamp duty or stamp paper costs for the sale
• Travel costs related to completing the sale.
• If the property is inherited, expenses like Legal work for a will or inheritance
• Getting a succession certificate
• Executor’s fees in some cases.

B. Sale of shares

When you sell shares, you can deduct the following:

• Broker’s commission paid for selling the shares
• But Securities Transaction Tax (STT) cannot be deducted

C. Sale of jewellery

When jewellery is sold:

• If you used a broker to find a buyer, their fee can be deducted from the sale price.