When you make investment decisions, at what stage do you start thinking about the capital gains tax in India? Do you factor it in before investing or do you think about it later? If you plan to consider it later, these taxes on your investments might come as a surprise, sometimes an unpleasant one.

To avoid such surprises, let us understand what capital gains tax is in detail.

What is capital gains tax?

When you redeem an investment, be it stocks, debt, mutual funds or gold, you make capital gains. These gains add to your income and attract a tax called capital gains tax.

You will be required to pay this tax during the financial year in which the investment was redeemed. 

Classification of capital gains taxes

Capital gains tax can be classified as:

1. Short-term capital gains tax
2. Long-term capital gains tax

The criteria for short and long-term depends on the type of the capital asset:

• For land, property and similar assets: 24 months
• If sold before 24 months from the date of purchase, it is called short-term capital gain 
• If sold after 24 months from the date of purchase, it is called long-term capital gain
• For equity, bond, gold and mutual fund, capital gains tax on holding these asset classes and similar assets: 12 months
• If sold before 12 months from the date of purchase, it is called short-term capital gain
• If sold after 12 months from the date of purchase, it is called long-term capital gain
• For debt-oriented assets like bonds and mutual funds holding these asset classes and similar assets: 36 months
• If sold before 36 months from the date of purchase, it is called short-term capital gain
• If sold after 36 months from the date of purchase, it is called long-term capital gain

Capital gains tax rates as per asset class

Capital gains tax rates also differ per asset class.

Look at the table below: 

Calculating capital gains taxes in India

Before we go into the details of the calculations, let us understand a few terms used for the calculation:

• Capital Assets

Capital assets include land, house, property, building, trademark, vehicles, leasehold rights, machinery, patents, and jewellery. 

• Full Value Consideration

The consideration to be received or received by the seller as a result of the transfer of the capital asset is known as the full value consideration. Capital gains tax applies in the year of transfer, even if the seller receives no consideration in that year.

• Cost of Acquisition

The cost of acquisition is the sum the seller paid to acquire the capital asset in the first place.

• Cost of Improvement

An expense incurred by the seller for making any alteration or additions to the capital asset is known as the cost of the improvement. 

Capital gains tax is calculated differently for different periods on different capital asset classes.

• Start with the full value of consideration.
• Deduct the indexed cost of acquisition + indexed cost of transfer + indexed cost of improvement

Let us define the terms used in the above formula:

• Indexed cost of acquisition = (cost of acquisition x by the cost of inflation index of the acquisition year)/(cost of inflation index of the transfer year)
• Indexed cost of transfer = (brokerage paid for arranging the deal, legal and other expenses x cost of inflation index of the improvement year)/(cost of inflation index of the transfer year)
• Indexed cost of the improvement = (cost of improvement x cost of inflation index of the improvement year)/(cost of inflation index of the transfer year)
• Long-term Capital Gains Tax = (Full Value Consideration) - (indexed cost of acquisition) + (transfer) + (indexed cost of improvement)

Short Term Capital Gains Tax

• Start with the full value of consideration.
• Deduct the cost of acquisition + cost of transfer + cost of improvement.
• The final amount will be short-term capital gain.
• Short-term capital gain = full value consideration - (cost of acquisition + cost of transfer + cost of improvement).

Things to keep in mind

Capital gains tax comes into play during exit, not entry

You probably have a broad idea about the capital gains tax on investment. However, you may choose to consider it in detail at a later stage. This is because the capital gains tax comes into play only when you exit the investment. You do not pay any capital gains tax when you enter an investment. 

Enter an investment with an exit strategy and time horizon

When you enter an investment without considering an exit strategy and time horizon, it is like doing only half of the homework. Having a clear exit strategy and time horizon frame is important. After knowing all the capital gains tax implications, you can ask yourself: 

• Does the investment still match my investment goal? 
• Does it still match my risk appetite (capacity to take risks)? 
• Am I comfortable entering the investment knowing fully well when and how much capital gains tax I will have to pay when I exit?

Conclusion

When you enter an investment, the potential risk and reward are all that people might tell you to focus on. However, the capital gains tax implications are also an important factor to consider as you make an investment decision. It can determine whether the investment was a profitable or a loss-making one for you.

They say the devil is in the details. Doing your homework on capital gains tax in India can help you plan better from the start of your investment journey. 

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Frequently asked questions

1. How do I avoid capital gains tax?

These are the steps on how to save on capital gains tax:

• Use the available exemption if you are selling an old house to buy a new house
• Purchase Capital Gains Bonds
• Invest in Capital Gains Accounts Scheme
• Invest for the long term
• Use capital losses to offset gains

2. What is the capital gains tax in India on a property sale?

Capital gains tax is chargeable on the profit earned from the sale of house property: 

• If you sell the property within two years of buying, it will be termed short-term capital gain. This will be part of your income for that year. You will be taxed as per the tax bracket you fall under.
• If you sell the property after two years of buying, it will be termed long-term capital gain. Long-term capital gain is taxed at 20.6%.

3. To what extent is capital gains tax exempt in India?

Capital gains are added to your income. Assuming that you have no other income except capital gains, these are the basic exemption limits on your income.

• The exemption limit is ₹5 lakh for resident individuals aged 80 years or above.
• The exemption limit is ₹3 crore for resident individuals aged 60 years or above but below 80 years.
• The exemption limit is ₹2.5 lakh for resident individuals of the age below 60 years.
• The exemption limit is ₹2.5 lakh for non-resident individuals, regardless of the age of the individual.
• The exemption limit is ₹2.5 lakh for Hindu Undivided Family (HUF).