Capital gains are the profits accrued through the sale of capital assets. The 2 types of capital gains are long-term and short-term. Long-term capital assets are those held for 36 months or more, while short-term assets are held for a shorter duration.
Capital gains arise when you sell capital asset for an amount that is more than what you paid for it. Capital assets are any investment products like mutual funds, stocks or any real estate product like land, house etc. An increase in the value of any of these when you sell them is termed as capital gain. Similarly, a capital loss is suffered in case there is a decrease in the value of an asset with respect to its purchase price.
A realized capital gain occurs only when you actually sell the asset at a higher price than its original purchase price.
Tax on Capital Gains
Calculation of tax is dependent upon the type of capital gain.
- Calculation of tax on short-term capital gains is simpler than that on long-term gains. For short-term gains, the gain is added to the total income and then the Income Tax is calculated based on the tax bracket that you fall in.
- Calculation of tax on long-term capital gains is a slightly trickier business. Since long-term capital assets are held for longer periods, inflation also factors in while computing tax on long-term capital gains.
Cost Inflation Index (CII)
Cost inflation Index is a term that comes into play when we talk about long-term capital gains. This index is fixed and is declared every year by the government. For calculating capital gains on long-term assets, indexation is used.
What is indexation?
Indexation is the process of adjusting prices based on a standard index so as to factor in the inflation rate also while calculating profits earned on sale of assets. Indexation is important because prices generally do not remain flat and tend to vary with time; hence, computing profits based on the original price of an asset is not an accurate measure of profit. Indexation takes into account inflation too and gives us a more reasonable figure for long-term capital gains.
Capital Gains Calculator
Calculating capital gains tax can be done using one of the online tools designed for the purpose. When calculating capital gains tax using a calculator, the following information is to be entered:
- Sale price.
- Purchase price.
- Details of the purchase such as the date, month and year of the purchase.
- Sale details such as the date, month and year of sale.
- Investment details, if any. The capital gains could have been invested in shares, debt funds, equity funds, real estate, gold or fixed maturity plans.
Once you have entered the information, the following details will be generated towards the calculation of your capital gains payable:
- The type of investment.
- Type of gain (whether short or long-term).
- Cost inflation index of the year of purchase.
- Cost inflation index of the year of sale.
- Difference between the purchase price and sale price.
- Time between the purchase and sale.
- Purchased index cost.
- Long-term capital gain without indexation.
- Long-term capital gain with indexation.
Calculate Capital Gains Formula
Short-term Capital Gains Tax:
In the case of short term capital gains, the computation is as given below:
Short-term capital gain= full value consideration – (cost of acquisition + cost of improvement + cost of transfer).
Long-term Capital Gains Tax:
To calculate the long-term capital gains tax payable, the following formula is to be used:
Long-term capital gain = full value of consideration received or accruing – (indexed cost of acquisition + indexed cost of improvement + cost of transfer), where:
Indexed cost of acquisition = cost of acquisition x cost inflation index of the year of transfer/cost inflation index of the year of acquisition.
Indexed cost of improvement = cost of improvement x cost inflation index of the year of transfer/cost inflation index of the year of improvement.
Capital Gains Rate
The rate at which capital gains is calculated varies from year to year. In the case of long-term capital gains, individuals are taxed at 20.6% (including education cess). There are no deductions that can be availed under capital gains tax.
Short-term capital gains tax is levied at the tax slab under which the individual falls under.
Capital Gains Shares
In the case of shares and stocks, the rates differ from long-term and short-term capital gains tax. The capital gains rate for the financial year 2016-2017 is as given below:
Short-term gains for stocks and mutual funds are taxed at 15%.
Short-term capital gain on debt mutual funds is taxed as per the income slab of the individual.
Long-term capital gains on debt mutual funds are taxed at 20% with indexation and at 10% without indexation.
On February 1, 2020, Finance Minister Nirmala Sitharaman announced the introduction of long-term capital gain tax on sale of equity shares over Rs.1 lakh. The capital gains rate as per the Union Budget 2020 can be given as below:
Long-term capital gains on equity shares are taxed at 10% without any indexation benefit.
In the Interim Budget 2020, there are no changes made to the provisions that govern the long-term capital gains (LTCG) on the sale of stocks.
How to Calculate Capital Gains Tax using CII
CII or Cost Inflation Index is used in the computation of long-term capital gains tax. The CII is notified through a notification issued by the Income Tax Department each financial year. The CII for the financial year 2016-16 is 1125. Individuals who are calculating their capital gains will have to use the CII in order to ascertain the indexed cost of acquisition, which is to be deducted from the full value in consideration.
Thus, the CII is applied to the cost of acquisition, following which the figure becomes the indexed cost of acquisition. Following this, the formula for computation of long-term or short-term capital gains is calculated.
When calculating the capital gains from the transfer of a long-term capital gains asset, a deduction can be claimed by indexing the cost of acquisition and the cost of improvement.
Example of Taxation On Long-Term Capital Gains (Real Estate)
Mr. Mishra bought a plot of land for Rs.10,00,000 in the year 2005. After 10 years had elapsed, in January 2015, he sold off his land for Rs.30,00,000.
Cost Inflation Index, CII= Index for financial year 2014-15/Index for financial year 2005-2006 = 1024/480 = 2.13
Indexed cost of purchase = CII x Purchase Price = 2.13 x 10,00,000 = 21,30,000
Long-term capital gain = Selling Price – Indexed cost = 30,00,000 – 21,30,000 = Rs.8,70,000
Tax on capital gain = 20% of 8,70,000 = 1,74,000
Tax on capital gains without Indexation (for stocks and mutual funds):
There is an option of not going the complicated route of indexation and directly computing capital gain tax. In this case, only 10% of the non-indexed capital gain is charged as tax. Individuals are free to choose to use indexation and pay 20% tax or ignore indexation and pay 10% on their capital gains.
Quick Tip: In case the asset (mutual fund, stocks) is held for a very long time and its value has multiplied manifold, chances are inflation wouldn’t affect profits drastically and as such it would be beneficial to pay 10% tax on the non-indexed gain instead of using indexation and paying 20%.
Tax Exemptions On Capital Gains
Government provides a number of exemptions which can be claimed on capital profits made. Here is a list of all the exemptions that can be claimed with respect to gains from capital assets.
- Section 54 of the Income Tax Act entitles a person to tax exemption on profit earned if that entire profit amount is used to buy another house. The seller can buy a new house within 2 years from the date of sale of his previous property or construct a new house within 3 years from the date of sale.
- Section 54 EC entitles an individual for tax exemption if the entire capital profit is invested in bonds issued by NHAI that is National Highway Authority of India or REC which is Rural Electrification Corporation. There is a limit to exemption under Section 54 EC and is Rs.50 lakh.
- In case you can’t find the right property to buy and you are unable to come up with a concrete plan in 2-3 years, you still can save tax on the capital profit earned. This can be achieved by investing gains in the Capital Gains Accounts Scheme (CGAS) in any public sector bank. This amount can then be claimed for tax exemption. However, you are required to invest this money within the period stated by the bank else the deposit is treated as capital gain and tax is deducted on it.
- In case you sell an agricultural land which is not within the limits of a civic body then tax is not levied on capital gain arising out of it.
- Capital gains is not applicable to sale of property if the entire amount is invested to set up a small scale or a medium scale industry. However, to avail tax exemption, the tools and machinery for manufacturing should be bought within 6 months from date of sale.
For tax computations, capital losses can be used to offset the effect of tax on capital gains. However, long-term capital losses can be set off against long-term gains only. Short-term capital losses can be set off against short-term as well as long-term capital gains.
Quick Tip: Long-term capital losses can be carried forward to a maximum of 8 years and set off against long-term capital gains.
Types of Capital Gains
Capital gains can broadly be classified into two types:
- Long-Term Capital Gains:Depending upon the type of asset, if it is held for more than 36 months it is termed as long-term capital asset and the gain on selling it is termed as long-term capital gains. For mutual funds and equities, this period is 12 months.
- Short-Term Capital Gains: Any asset that is sold within 36 months of purchasing it, is termed as short-term asset and the gain on selling the same is termed as short-term capital gain.
- How do I calculate capital gains tax on mutual funds?
- How to calculate capital gains tax on property?
Short-term capital gains tax is payable at a rate of 10% on all holdings.
Long-term capital gains tax is not payable on equity mutual funds, though the individual will have to declare income from the same when filing IT returns. Profits from the sale or transfer of non-equity or debt mutual funds will attract a tax of 20% with indexation benefit.
In case of short-term capital gain, capital gain = final sale price – (the cost of acquisition + house improvement cost + transfer cost).
In case of long-term capital gain, capital gain = final sale price – (transfer cost + indexed acquisition cost + indexed house improvement cost).