We often encounter clients who, after selling a property, seek our advice on the best investment strategies to maximize returns. When we inquire about their consideration of capital gains tax on the property sale, they often express confusion, questioning the need to pay taxes on the proceeds from selling their own property. This blog post aims to clarify common misconceptions about capital gains tax.
Demystifying Capital Gains
Capital gains are the profits earned from the sale of an asset, such as property, stocks, or bonds. This concept is integral to taxation, as the government levies taxes on such profits. In this blog post we analyse what this is, including distinctions between short-term and long-term gains, and the concept of indexation.
What are Capital Gains?
When you sell an asset for a price higher than its purchase price, the profit you earn is termed a "capital gain." For instance, if you buy a piece of land for ₹10 lakhs and sell it for ₹15 lakhs, the ₹5 lakhs you earn is a capital gain. Conversely, if the sale price is lower than the purchase price, it results in a "capital loss."
Types of Capital Gains: Short-Term vs. Long-Term
The classification of capital gains depends on the duration for which the asset is held before being sold.
Short-Term Capital Gains (STCG):
If you hold an asset for a short duration, typically less than 24 months, the gain from its sale is termed as STCG.
For listed equity shares and mutual funds, the holding period threshold is shorter—12 months.
Example: You purchase stocks worth ₹2 lakhs and sell them within 8 months for ₹3 lakhs. The ₹1 lakh profit is a short-term capital gain.
Long-Term Capital Gains (LTCG):
When assets are held for a longer period, usually exceeding 24 months (or 12 months for listed equities), the resulting gain qualifies as LTCG.
LTCG enjoys favorable tax treatment compared to STCG due to incentives for long-term investment.
Example: You buy a property for ₹50 lakhs and sell it after 4 years for ₹75 lakhs. The ₹25 lakhs is considered LTCG.
STCG Taxation: Short-term gains are taxed at the applicable income tax slab rates for the taxpayer, except for equities, which are taxed at 15%.
LTCG Taxation: Long-term gains often benefit from lower tax rates. For equities, LTCG over ₹1 lakh is taxed at 10% without indexation. For other assets, the rate is generally 20% with indexation.
Indexation: Adjusting for Inflation
Indexation is a mechanism that adjusts the purchase price of an asset to account for inflation, thereby reducing the taxable gain. It is available for LTCG (except equities).
How it works:
The purchase price is multiplied by the Cost Inflation Index (CII) for the year of sale and divided by the CII for the year of purchase.
This adjusted cost is used to calculate the gain.
Example: You bought a plot of land in 2010 for ₹20 lakhs and sold it in 2023 for ₹50 lakhs. The CII for 2010 was 167, and for 2023, it is 348. The indexed cost would be:
=₹20,00,000×(348/167)=₹41,67,000
The taxable gain would then be:
₹50,00,000−₹41,67,000=₹8,33,000
Without indexation, the taxable gain would have been ₹30 lakhs, significantly higher.
Exemptions on Capital Gains
The Income-tax Act provides avenues to reduce or eliminate capital gains tax liability:
Section 54: Exemption on LTCG from the sale of a residential property if the proceeds are reinvested in another residential property.
Section 54EC: Exemption on LTCG if invested in specific bonds.
Section 54F: Exemption for reinvesting gains from any long-term asset into a residential property.
To sum up, Capital gains taxation encourages long-term investments by offering lower tax rates and indexation benefits for LTCG. By understanding the distinctions between short-term and long-term gains and leveraging exemptions, taxpayers can optimize their financial planning.
The content made available in this article is for general informational purposes only. While every effort has been made to ensure the accuracy and completeness of the content, it should not be considered as a substitute for professional consultation.
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