When it comes to managing your finances and investments, understanding Capital Gains Tax in India is crucial. Whether you’re selling property, trading in mutual funds, or inheriting assets, capital gains tax impacts the net returns on your investments. In this guide, we delve deep into the intricacies of capital gains taxation, starting with the fundamentals and moving toward advanced concepts.
From defining capital assets and exploring their types to breaking down the tax rates for long-term and short-term capital gains, we cover it all.
You’ll learn how to calculate your capital gains, understand key terms, and navigate deductible expenses like the indexed cost of acquisition/improvement. If you’re looking for ways to save on taxes, we’ve detailed exemptions under Sections 54, 54F, 54EC, 54B, and 54D, along with strategies for reinvesting in specific bonds or utilizing the Capital Gains Account Scheme.
Lastly, we’ll also touch on saving taxes when selling agricultural land—a topic often overlooked but equally significant. Whether you’re a seasoned investor or a taxpayer planning to optimize your finances, this comprehensive guide will equip you with the knowledge to make informed decisions. Let’s dive in!
Heads of Income in Indian Taxation
The Income Tax Act classifies income into five broad categories:
- Income from Salary: Earnings from employment, including wages, pensions, and allowances.
- Income from House Property: Income derived from letting out a property.
- Income from Profits and Gains of Business or Profession: Revenue earned from business operations or professional services.
- Income from Capital Gains: Profits from the sale of capital assets like property or stocks.
- Income from Other Sources: A residual category that captures all other income.
What is Capital Gains Tax in India?
Capital Gains Tax is the tax levied on the profit earned from the sale of a capital asset. In India, capital gains tax is an integral part of the Income Tax Act, 1961, and is applicable to both individuals and businesses. The tax is classified into two categories based on the holding period of the asset:
- Short-Term Capital Gains (STCG): Arises when a capital asset is sold within a specified short-term period, generally less than 36 months (or 24/12 months for certain assets).
- Long-Term Capital Gains (LTCG): Applies when the holding period exceeds the short-term limit.
The tax rates for STCG and LTCG differ significantly, with LTCG often enjoying indexation benefits and lower rates.
Defining Capital Assets
A capital asset is any property owned by an individual or a business, whether connected to their profession or not. This includes tangible assets like land, buildings, vehicles, and jewelry, as well as intangible assets like shares, bonds, and mutual funds.
Certain exceptions, however, are not considered capital assets, such as:
- Stock-in-trade (goods held for business purposes).
- Personal effects like clothing or furniture used for personal purposes.
- Agricultural land situated in rural areas of India.
- 6½% Gold Bonds (1977), 7% Gold Bonds (1980), or National Defence Gold Bonds (1980) issued by the Central Government.
- Special Bearer Bonds (1991).
- Gold Deposit Bonds issued under the Gold Deposit Scheme (1999) or Deposit Certificates issued under the Gold Monetisation Scheme, 2015, and Gold Monetisation Scheme, 2019, as notified by the Central Government.
Definition of Rural Area (Effective from FY 2013-14)
A rural area is any area that meets the following conditions:
- It lies outside the jurisdiction of a municipality or cantonment board with a population of 10,000 or more.
- It does not fall within the specified distances from the local limits of a municipality or cantonment board, as outlined below:
| Shortest Aerial Distance from Municipality/Cantonment Board | Population (Last Census) |
|---|---|
| < 2 km | > 10,000 |
| > 2 km but < 6 km | > 1,00,000 |
| > 6 km but < 8 km | > 10,00,000 |
Understanding what constitutes a capital asset is essential for correctly identifying taxable gains during a transaction.
Types of Capital Assets
Capital assets are broadly classified based on their holding period:
1. Short-Term Capital Assets
- Assets held for 36 months or less (reduced to 24 months for immovable properties like land or buildings and 12 months for listed shares, equity-oriented mutual funds, and certain bonds).
- Gains from the sale of these assets are categorized as short-term capital gains and are taxed at higher rates without indexation benefits.
2. Long-Term Capital Assets
- Assets held for more than 36 months (or 24/12 months as specified above).
- Gains from the sale are categorized as long-term capital gains and often benefit from lower tax rates and indexation to adjust for inflation.
This classification determines the applicable tax rate and the availability of benefits like deductions or exemptions under various sections of the Income Tax Act.
By understanding these fundamental aspects, taxpayers can plan their investments and sales strategically to minimize their tax liability and maximize their net returns.
Capital Gains Classification: Capital gains from the sale of units of a specified mutual fund acquired on or after April 1, 2023, and market-linked debentures will always be classified as short-term capital gains, irrespective of the holding period.
Updated Holding Period Rules (Effective FY 2024-25):
The 36-month holding period for asset classification has been abolished.
There are now only two holding periods for determining whether an asset is long-term or short-term:
- 12 months: Applicable for listed securities. Any listed security held for more than 12 months will be considered long-term.
- 24 months: Applicable for all other assets. Assets held for more than 24 months will be classified as long-term.
Tax Rates – Long-Term Capital Gains and Short-Term Capital Gains
The tax rates applicable to capital gains depend on the nature of the capital asset and the holding period:
1. Long-Term Capital Gains (LTCG)
Long-term capital gains arise when a capital asset is held for more than the specified threshold period (12, 24, or 36 months, depending on the asset type).
- Listed Equity Shares and Equity-Oriented Mutual Funds:
LTCG exceeding ₹1,00,000 in a financial year is taxed at 10% without indexation under Section 112A. Gains up to ₹1,00,000 are tax-free. - Other Assets (e.g., Property, Unlisted Shares):
Taxed at 20% with indexation benefits, which adjust the acquisition cost for inflation.
2. Short-Term Capital Gains (STCG)
Short-term capital gains arise when a capital asset is sold within the threshold period.
- Listed Equity Shares and Equity-Oriented Mutual Funds:
STCG is taxed at a flat rate of 15% under Section 111A.But Rebate can be claimed u/s 87A. - Other Assets:
Gains are taxed at the individual’s applicable income tax slab rate without indexation.
Tax on Equity and Debt Mutual Funds
Mutual funds are categorized based on their underlying asset allocation, primarily into equity-oriented and debt-oriented funds, with different tax treatments:
1. Tax on Equity-Oriented Mutual Funds
- Short-Term Capital Gains (STCG): Taxed at 15%, irrespective of the investor’s income tax slab. But Rebate can be claimed u/s 87A.
- Long-Term Capital Gains (LTCG): Gains above ₹1,00,000 in a financial year are taxed at 10% without indexation. Gains up to ₹1,00,000 are exempt.
2. Tax on Debt-Oriented Mutual Funds
- Short-Term Capital Gains (STCG): Taxed at the individual’s income tax slab rate, making it less tax-efficient for short-term investments.
- Long-Term Capital Gains (LTCG): Taxed at 20% with indexation benefits, which reduce the tax liability by accounting for inflation over the holding period.
Tax Rules for Debt Mutual Funds
Recent changes in tax rules have altered the landscape for debt mutual fund taxation:
Budget 2024 Impact: Debt mutual funds held after April 1, 2023, no longer qualify for indexation benefits. This means that LTCG on such funds is taxed at the individual’s income tax slab rate, aligning the treatment closer to short-term capital gains.
Applicability: These rules apply to all non-equity funds, including international funds, gold funds, and fixed-maturity plans (FMPs).
Key Updates from Budget 2024
Debt Mutual Funds: For purchases after April 1, 2023, long-term capital gains tax with indexation benefits is no longer available, significantly altering their tax efficiency. Gains are now taxed at the investor’s income tax slab rate.
Listed Equity shares and Equity-Oriented Funds: With effect from 23rd July 2024, LTCG above ₹1,25,000 will be taxed at 12.5% without indexation and STCG at 15%.
Real Estate: Taxation on immovable property remains unchanged, with a reduced holding period of 24 months for LTCG eligibility
How to Calculate Short-Term Capital Gains
Short-term capital gains (STCG) arise when a capital asset is sold within the prescribed short-term holding period. The calculation involves identifying the sale price, deducting applicable costs, and applying the relevant tax rate.
Formula for STCG:
STCG = Full Value of Consideration (Sale Price) – [Cost of Acquisition + Cost of Improvement + Expenses on Sale]
Steps to Calculate STCG:
Determine the Full Value of Consideration (FVC):
This is the total sale price or consideration received from selling the asset.Deduct the Cost of Acquisition:
This is the original purchase price of the asset.Deduct the Cost of Improvement:
If the asset was improved during the holding period (e.g., renovations to a property), the cost of such improvements is subtracted.Deduct Expenses on Sale:
Any expenses directly incurred during the sale of the asset, such as brokerage fees, legal charges, or stamp duty, can be deducted.Apply the Relevant Tax Rate:
- For equity shares and equity-oriented mutual funds, STCG is taxed at 15% under Section 111A.
- For other assets, STCG is taxed as per the individual’s income tax slab rate.
How to Calculate Long-Term Capital Gains
Long-term capital gains (LTCG) arise when a capital asset is sold after the specified long-term holding period. Unlike STCG, LTCG calculations may include indexation benefits to adjust the acquisition cost for inflation.
Formula for LTCG:
LTCG = Full Value of Consideration (Sale Price) – [Indexed Cost of Acquisition + Indexed Cost of Improvement + Expenses on Sale]
Steps to Calculate LTCG:
Determine the Full Value of Consideration (FVC):
This is the total sale price or consideration received.Calculate the Indexed Cost of Acquisition (ICA):
- ICA = Original Cost of Acquisition × (CII for the Year of Sale / CII for the Year of Purchase)
- CII refers to the Cost Inflation Index published annually by the government.
Calculate the Indexed Cost of Improvement (ICI):
- Similar to ICA, any improvement costs incurred are adjusted for inflation.
Deduct Expenses on Sale:
Expenses such as brokerage, legal fees, or stamp duty incurred during the sale are deducted.Apply the Relevant Tax Rate:
- For equity shares and equity-oriented mutual funds, LTCG exceeding ₹1,00,000 is taxed at 10% without indexation.
- For other assets, LTCG is taxed at 20% with indexation.
Deductible Expenses
When calculating capital gains, deductible expenses refer to costs directly related to acquiring, improving, or selling a capital asset. These expenses are subtracted from the Full Value of Consideration (FVC) to arrive at the taxable gain.
Types of Deductible Expenses:
Cost of Acquisition:
The original purchase price of the asset, including any associated costs like registration charges or stamp duty.Cost of Improvement:
Expenditures incurred on modifications, additions, or renovations that enhance the value of the asset.Expenses on Sale:
Costs incurred during the sale of the asset, such as:- Brokerage or commission fees.
- Legal expenses.
- Advertising costs for sale.
- Stamp duty or transfer fees.
By including these deductible expenses, taxpayers can significantly reduce their taxable capital gains.
Indexed Cost of Acquisition/Improvement
Indexation is a benefit provided for long-term capital gains, where the cost of acquisition and improvement is adjusted for inflation using the Cost Inflation Index (CII). This reduces the taxable gain by reflecting the actual inflationary impact on the asset’s cost over time.
Formula for Indexed Cost of Acquisition (ICA):
ICA = Original Cost of Acquisition × (CII for Year of Sale / CII for Year of Purchase)
Formula for Indexed Cost of Improvement (ICI):
ICI = Original Cost of Improvement × (CII for Year of Sale / CII for Year of Improvement)
Key Points About Indexation:
Applicability:
Indexation benefits apply only to long-term capital gains, typically for assets like real estate, jewelry, and debt-oriented mutual funds (purchased before April 1, 2023).Cost Inflation Index (CII):
The CII is published annually by the Central Board of Direct Taxes (CBDT). It reflects inflation trends, making it easier to compute adjusted costs.
Example of Indexed Cost Calculation
- Original Purchase Price: ₹5,00,000
- Year of Purchase: 2015 (CII for 2015 = 254)
- Year of Sale: 2024 (CII for 2024 = 348)
Indexed Cost of Acquisition (ICA) = ₹5,00,000 × (348 / 254) = ₹6,85,039
If there were improvements:
- Improvement Cost: ₹2,00,000
- Year of Improvement: 2018 (CII for 2018 = 280)
Indexed Cost of Improvement (ICI) = ₹2,00,000 × (348 / 280) = ₹2,48,571
Total Indexed Costs:
₹6,85,039 + ₹2,48,571 = ₹9,33,610
These indexed costs are then deducted from the Full Value of Consideration (FVC) to calculate the taxable long-term capital gains.
Note-
Improvements Prior to April 1, 2001: Any improvements made to an asset before April 1, 2001, should not be considered for tax computation.
Indexation Benefit on Long-Term Assets:
The indexation benefit, which was previously available on the sale of long-term assets, was initially removed. However, following public backlash, the government introduced an amendment allowing taxpayers to compute taxes using either of the following options:
- 12.5% tax rate without indexation, or
- 20% tax rate with indexation.
This amendment applies to both real estate transactions and unlisted equity transactions conducted before July 23, 2024.
Exemption on Capital Gains
The Income Tax Act, 1961 provides several provisions for exemptions on capital gains, aimed at encouraging reinvestment and promoting asset utilization. These exemptions apply under specific conditions and are governed by various sections of the Act.
Section 54: Exemption on Sale of House Property on Purchase of Another House Property
Applicability: Applies to long-term capital gains arising from the sale of a residential house property.
Conditions:
- The capital gains must be reinvested in purchasing or constructing upto 2 residential house property in India. (prior to Budget 2019, the exemption of the capital gains was limited to only 1 house property)
- The new property must be purchased:
- Within 1 year before or 2 years after the sale, or
- Constructed within 3 years from the sale.
- If the new property is sold within 3 years, the exemption is reversed, and the amount is added to taxable income.
- The exemption on two house properties will be allowed once in the lifetime of a taxpayer, provided the capital gains do not exceed Rs. 2 crores.
Exemption Amount: It is lower of the Capital gains amount or Cost of the new residential property.
Section 54F: Exemption on Capital Gains on Sale of Any Asset Other Than a House Property
Applicability: For long-term capital gains arising from the sale of any asset except a residential house.
Conditions:
- The taxpayer must not own more than one residential house property (other than the new property) at the time of sale.
- The entire sale consideration must be reinvested in a new residential house in India.
- The new property must be purchased:
- Within 1 year before or 2 years after the sale, or
- Constructed within 3 years from the sale.
- If the new property is sold within 3 years, the exemption is reversed, and the amount is added to taxable income.
Exemption Amount:
Proportionate exemption is calculated as:
Exemption = Capital Gains × (Investment in New Property / Net Sale Consideration)
Section 54EC: Exemption on Sale of House Property on Reinvesting in Specific Bonds
Applicability: For long-term capital gains from the sale of land, building, or house property.
Conditions:
- The capital gains must be reinvested in specified bonds (such as those issued by National Highway Authority of India (NHAI) or Rural Electrification Corporation (REC)) within 6 months of the sale.
- The investment must be held for at least 5 years (increased from 3 years).
Exemption Amount is lower of Capital gains amount and Amount invested in bonds (maximum limit: ₹50,00,000 per financial year).
Section 54B: Exemption on Capital Gains From Transfer of Land Used for Agricultural Purposes
Applicability: For capital gains arising from the transfer of urban agricultural land used for agricultural purposes by the taxpayer or their parents or HUF for at least 2 years immediately before the sale.
Conditions:
- The gains must be reinvested in purchasing other agricultural land within 2 years of the sale.
- The new land must be used for agricultural purposes.
- The new agricultural land, which is purchased, should not be sold within a period of 3 years from the date of its purchase. In case you are not able to purchase agricultural land before the date of furnishing of your income tax return, the amount of capital gains must be deposited before the date of filing of return in the deposit account in any branch (except rural branch) of a public sector bank according to the Capital Gains Account Scheme, 1988.
Exemption Amount is lower of Capital gains amount or Cost of the new agricultural land.
Section 54D: Exemption on Capital Gains on Transfer of Land and Building Used for Industrial Undertakings
Applicability: For capital gains arising from the compulsory acquisition of land or building used for an industrial undertaking for at least 2 years.
Conditions:
- The compensation received must be reinvested in acquiring or constructing another land/building for industrial purposes within 3 years.
- If such investment is not made before the date of filing of return of income, then the capital gain has to be deposited under the CGAS.
Exemption Amount is lower of Capital gains amount and Cost of the new asset.
When Can You Invest in the Capital Gains Account Scheme?
Capital Gains Account Scheme (CGAS) provides a way to claim exemptions even if the taxpayer has not yet reinvested the capital gains.
Applicability: If the timeline for reinvestment (under Sections 54, 54F, or 54B) is not met by the end of the financial year, the unutilized gains can be deposited in a Capital Gains Account Scheme with a bank as finding a seller, arranging the funds and getting the paperwork in place for a new property is a time-consuming process.
Conditions:
- The deposited amount must be used exclusively for the intended reinvestment within the specified time period.
- If unused by the deadline, the deposited amount becomes taxable in the year of expiry as short term capital gains.
Saving Tax on Sale of Agricultural Land
The sale of agricultural land may result in capital gains, which could attract taxes under certain conditions. However, the Income Tax Act, 1961, provides provisions to reduce or completely eliminate the tax liability in such cases.
Types of Agricultural Land and Taxability
Rural Agricultural Land:
- Not considered a “capital asset” under Section 2(14).
- No capital gains tax applies on the sale of rural agricultural land.
Urban Agricultural Land:
- Classified as a “capital asset”.
- Gains from the sale are taxable as either short-term or long-term capital gains, depending on the holding period.
How to Save Tax on Sale of Agricultural Land?
1. Section 54B: Exemption on Sale of Agricultural Land
- Applicable if the land was used for agricultural purposes by the taxpayer or their family for 2 years immediately before the sale.
- The capital gains must be reinvested in purchasing another agricultural land within 2 years from the date of sale.
- Exemption Amount:
- The lower of the capital gains amount or the cost of the new land is exempt from tax.
Example:
- Sale Price: ₹50,00,000
- Purchase Price: ₹20,00,000
- Capital Gains: ₹30,00,000
- New Agricultural Land Cost: ₹25,00,000
Taxable Gain = ₹30,00,000 – ₹25,00,000 = ₹5,00,000
2. Capital Gains Account Scheme (CGAS)
- If the capital gains are not immediately reinvested, the taxpayer can deposit the amount in a Capital Gains Account Scheme (CGAS) before the end of the financial year.
- The deposited amount must be utilized to purchase agricultural land within the prescribed period (2 years).
3. Rural Land Classification
Ensure the agricultural land is classified as “rural” as per the criteria:
- Located beyond 2 km from a municipal limit with a population of up to 10,000.
- Located beyond 6 km for populations between 10,001 and 1,00,000.
- Located beyond 8 km for populations above 1,00,000.
If classified as rural, the land sale is not taxable.
4. Invest in Eligible Bonds (Section 54EC)
- If the land does not qualify for exemption under Section 54B, reinvest the capital gains in specified bonds like NHAI or REC within 6 months of the sale.
- Maximum investment: ₹50,00,000 per financial year.
- Holding period is minimum 5 years.
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