Capital Gains - Types, Calculation and Tax Exemption on Capital Gains

When you sell something like a house, property, or even stocks, and make a profit, that profit is known as capital gain. If you bought something for ₹5,00,000 and sold it for ₹7,00,000, the ₹2,00,000 difference is your capital gain. The government taxes these profits, and this is called Capital Gains Tax. There are two types of capital gains: short-term and long-term. The tax rate you pay on your capital gains depends on how long you held the asset before selling it. In India, the tax rules differ for short-term and long-term capital gains. The government also allows certain exemptions to help reduce the tax burden on capital gains. Let’s dive into the details of what capital gains are, how they are calculated, and how you can save on tax with capital gains exemptions.

Types of Capital Gains

There are two primary types of capital gains based on the holding period of the asset. These are:

1. Short-Term Capital Gains (STCG):

   • Short-term capital gains are the profits you make from selling an asset that you have held for less than a year (or more than 3 years for property).
   • The tax rate on short-term capital gains is higher than long-term capital gains because the government encourages people to hold investments for a longer period.
   • For example, if you sell stocks within a year of buying them and make a profit, that profit is considered short-term capital gain.

2. Long-Term Capital Gains (LTCG):

   • Long-term capital gains are the profits you make from selling an asset that you have held for a longer period (more than one year for stocks and more than 3 years for property).
   • Long-term capital gains are taxed at a lower rate than short-term capital gains to encourage long-term investments.
   • For instance, if you sell property after holding it for 3 years and make a profit, that profit will be considered long-term capital gain and will be taxed at a lower rate.

Type of Capital Gain

Time Held

Tax Rate

Short-Term Capital Gain

Less than 1 year (for stocks)

Higher tax rate

Long-Term Capital Gain

More than 1 year (for stocks)

Lower tax rate

Related read: Income taxes on Capital gains

Calculation of Capital Gains

Calculating capital gains is simple once you understand the basic concept. You just need to subtract the amount you paid for the asset (its purchase price) from the amount you sold it for (its selling price). The difference is your capital gain.

Formula for Capital Gain:

Capital Gain = Selling Price – Purchase Price

Example:
Let’s say you bought a piece of land for ₹10,00,000 and later sold it for ₹15,00,000. The calculation for capital gain is:

Capital Gain = ₹15,00,000 – ₹10,00,000 = ₹5,00,000

So, your capital gain is ₹5,00,000, and you’ll be taxed on this amount based on whether it’s short-term or long-term.

Indexed Cost of Acquisition

Sometimes, the value of the asset increases just due to inflation, not because the asset is more valuable. To make sure you’re only taxed on the real gain, the government adjusts the purchase price for inflation using something called the Cost Inflation Index (CII). This helps you avoid paying taxes on the inflationary part of your profit.

Here’s how you calculate the Indexed Cost of Acquisition:

Formula:

Indexed Cost of Acquisition = (Original Cost x CII of the year of sale) / CII of the year of purchase

Example:

If you bought a house for ₹10,00,000 in 2010, and the CII for 2010 is 167, and the CII for 2023 is 317, then:

Indexed Cost of Acquisition = (₹10,00,000 x 317) / 167 = ₹18,98,800

So, the government treats the purchase price as ₹18,98,800 for tax purposes, which lowers your taxable gain and reduces the tax burden.

Indexed Cost of Improvement

If you spent money improving the asset (like doing renovations on your house), the cost of those improvements can also be adjusted for inflation. This is known as the Indexed Cost of Improvement.

The formula is:

Formula:

Indexed Cost of Improvement = (Improvement Cost x CII of the year of sale) / CII of the year of improvement

Example:

If you spent ₹2,00,000 on improving the property in 2015, and the CII for 2015 is 254 and the CII for 2023 is 317, then:

Indexed Cost of Improvement = (₹2,00,000 x 317) / 254 = ₹2,50,000

Now, you can add ₹2,50,000 to your purchase price when calculating your capital gain, which reduces the taxable gain further.

Tax Exemptions on Capital Gains

The government provides several exemptions to help reduce the tax on capital gains. Here are some of the key exemptions available:

Exemption for Residential Property:

If you sell a residential property and invest the profits in buying another residential property within a certain time frame, you can claim an exemption on the capital gains tax under Section 54 of the Income Tax Act. This encourages investment in real estate.

Exemption for Agriculture Land:

If you sell agricultural land and invest the capital gain in another agricultural property, you may be eligible for tax exemptions under Section 54B.

Also read: Agricultural income in India: Types, Rules & Tax guide

Exemption under Section 10(38):

This applies to long-term capital gains on listed securities like stocks, bonds, and mutual funds. The first ₹1 lakh of LTCG is tax-free.

Exemption for Bonds:

If you invest the capital gains from the sale of property in certain bonds under Section 54EC, you can get a tax exemption.

Reinvestment Exemption:

You can reinvest your capital gains into another asset, such as property or bonds, and claim an exemption on the profit.

Capital gains are an important part of investing, whether in real estate, stocks, or bonds. Understanding how to calculate your capital gains and knowing about the available tax exemptions can help you reduce your tax burden. By applying indexation and reinvesting in certain assets, you can lower your taxable gains and save on taxes. Remember to always keep track of your purchase price, improvement costs, and the date of sale to calculate your capital gains accurately and take advantage of exemptions.