Capital Gains and Taxes: A Complete Guide

Important Keyword: Capital Gains, Income from House Property, Income Source.

What is Capital Gain?

Capital Gain is simply the profit or loss that arises when you transfer a Capital Asset. If you sell a Long Term Capital Asset, you will have Long Term Capital Gains and if you sell a Short Term Capital Asset, you will have a Short Term Capital Gain. If the result from the sale is negative, you will have a capital loss. The Capital Gain will be chargeable to tax in the year in which the transfer of capital assets takes place.

What is a Capital Asset?

A capital asset encompasses any property you own, regardless of its connection to your business or profession. This includes movable and immovable assets, tangible and intangible assets, rights, and choices in actions. Examples of capital assets include house property, land, buildings, goodwill, patents, trademarks, machinery, jewelry, cars, and paintings.

However, certain assets are excluded from the definition of capital assets:

1. Stock in trade, consumables, or raw materials held for business or professional purposes.
2. Personal effects like clothing or furniture held for personal use.
3. Agricultural land situated outside specified areas based on population density.
4. Gold Bonds, Special Bearer Bonds, and Gold Deposit Bonds issued by the Government of India.

The term “transfer” refers to any action that leads to the profit or gain from a capital asset, constituting a capital gain. Transfer includes:

• Sale, exchange, or relinquishment of the asset.
• Extinction of any rights in the asset.
• Compulsory acquisition of an asset.
• Conversion of a capital asset into stock in trade.
• Maturity or redemption of zero coupon bonds.
• Any other transaction affecting the possession or enjoyment of an immovable property.
• Transactions involving gift, will, or inheritance of a capital asset are not considered transfers for tax purposes. Additionally, if the asset transferred is not a capital asset, the provisions of capital gains tax do not apply.

What is Long Term and Short-Term Capital Asset?

Yes, the classification of assets as short-term or long-term capital assets depends on the duration of ownership before their sale. Typically, assets held for 36 months or less are considered short-term, while those held for more than 36 months are categorized as long-term.

However, there are exceptions to this rule:

1. Equity shares or preference shares, debentures or government securities, units of UTI, units of equity-oriented mutual funds, and zero-coupon bonds are treated as short-term capital assets if held for 12 months or less. If held for more than 12 months, they are classified as long-term capital assets.
2. Other assets, not falling under the exceptions mentioned above, follow the general rule of 36 months for determining short-term or long-term status.

It’s essential to recognize these distinctions, as the tax implications vary based on whether the gains or losses arise from short-term or long-term capital assets. The table given below defines period of holding for different classes of asset in order to be classified as short term or long term:

Asset	Period of holding	Short Term / Long Term
Immovable property	< 24 months	Short Term
	>24 months	Long Term
Listed equity shares	<12 months	Short Term
	>12 Months	Long Term
Unlisted shares	<24 months	Short Term
	>24 months	Long Term
Equity Mutual funds	<12 months	Short Term
	>12 months	Long Term
Debt mutual funds	<36 months	Short Term
	>36 months	Long Term
Other assets	<36 months	Short Term
	>36 months	Long Term

Note: Determination of period of holding is important because it impacts the method of calculating Capital Gains and also the tax rates.

How to determine the holding period if the asset was gifted?

When calculating Capital Gains, various factors come into play, depending on whether the asset is categorized as a Long Term or Short Term Capital Asset. Here’s a breakdown of key terms and concepts involved in the process:

1. Full Value of Consideration:
   • This refers to the total amount received or expected to be received by the seller upon transferring the asset to the buyer. Capital Gain is taxable in the year of transfer, regardless of when the consideration is received.
2. Cost of Acquisition:
   • The cost at which the seller initially acquired the asset is known as the Cost of Acquisition.
3. Cost of Improvement:
   • Any expenses incurred for improving, repairing, or enhancing the asset after April 1, 1981, are considered as the Cost of Improvement. These costs are factored in when determining the Capital Gain.
4. Indexation:
   • Indexation involves adjusting the cost of acquisition and improvement using the Cost Inflation Index (CII) notified by the Central Government annually. This adjustment accounts for inflation, ensuring that the purchasing power of the asset remains intact over time.

Additionally, it’s important to consider certain scenarios that impact the calculation of the holding period:

• In cases where the asset was received as a gift, inheritance, or through succession, the holding period of the previous owner is also included in the total holding period for the current owner.
• For bonus shares or right shares, the holding period is calculated from the date of their allotment.

How to Calculate Short Term Capital Gains Tax?

Particulars	Amount
Full Value of Consideration	XXXX
Less:​ Expenditure incurred exclusively in connection with the transfer.​​ Cost of Acquisition. ​Cost of Improvement.	​(XXX) ​​(XXX)​ (XXX)
Less: Exemption under Section 54B	(XXX)
Short Term Capital Gain (1-2-3)	XXXX

How to Calculate Long Term Capital Gain Tax?

Particulars	Amount
Full Value of Consideration	XXXX
Less:​ Expenditure incurred exclusively in connection with the transfer. ​​Index* Cost of Acquisition. ​Index* Cost of Improvement.	(XXX) ​​ (XXX) ​(XXX)
Less: Exemption under Section 54, 54EC, 54F, 54B, 54D, 54EE, 54GB	(XXX)
Long Term Capital Gain	XXXX

Can I claim any expenses as a deduction from the full value of consideration?

Yes, you can claim certain expenses as deductions from the full value of consideration when calculating Capital Gains. These expenses must be directly related to the transfer of the property. Here’s a breakdown of allowable expenses for different types of sales transactions:

1. Sale of Shares/Stocks:
   • Brokerage or sales commission paid to brokers or agents.
   • Note that Securities Transaction Tax (STT) is not allowed as a deduction.
2. Sale of House Property:
   • Commission or brokerage paid to property agents or brokers.
   • Stamp duty paid on the transfer of property.
   • Any travel expenses incurred to facilitate the sales transaction.
   • Legal charges associated with obtaining a succession certificate or executor fees in case of property transfer through inheritance.
   • Litigation expenses for claiming enhanced compensation in case of compulsory acquisition.

It’s important to remember that these expenses are deductible only for the purpose of calculating Capital Gains and cannot be claimed as deductions from any other heads of income. Additionally, the cost of acquisition and cost of improvement can also be deducted from the sales consideration.

Taxation on Long-term and Short-term Gains

Type of Capital Gain	Tax Rate
Long Term Capital Gain under Section 112 (when Securities Transaction Tax is not applicable)	20% + Surcharge and Education Cess
Long Term Capital Gain under Section 112A (when Securities Transaction Tax is applicable)	10% over and above INR 1 lakh
Short Term Capital Gain (when Securities Transaction Tax is not applicable)	Normal slab rate applicable to Individuals
Short Term Capital Gain under Section 111A (when Securities Transaction Tax is applicable)	15% + Surcharge and Education Cess

The taxability of gains from the sale of Equity and Debt mutual funds are different. Funds with more than 65% of the portfolio consisting of equities are called Equity Funds.

	Short Term Capital Gain	Long Term Capital Gain
Debt Funds	Normal slab rate applicable to Individuals	20% with Indexation + Surcharge and Education Cess
Equity Funds	15% + Surcharge and Education cess	Exempt

Note: Unlike Equity mutual funds, debt funds have to be held for more than 36 months to qualify as Long Term Capital Assets.

Capital Gain Exemption

Indeed, the Income Tax Act provides avenues for total or partial exemption from Capital Gains tax under various sections. Taxpayers can benefit from multiple Capital Gains exemptions offered by these sections simultaneously. However, it’s crucial to note that the total amount of exemption claimed cannot surpass the total Capital Gain amount.

These exemptions serve as valuable tools for taxpayers to reduce their tax liabilities and optimize their financial planning strategies. By leveraging these provisions effectively, taxpayers can maximize their tax savings while ensuring compliance with the relevant tax regulations.

Section	Type of Asset Sold	Type of Asset Purchased	Taxpayer Type
Section 54	House Property (LTCA)	House Property	Individual/HUF
Section 54F	Any asset other than House Property (LTCA)	House Property	Individual/HUF
Section 54EC	Land or Building or both (LTCA)	Bonds of NHAI/REC	Any Taxpayer
Section 54B	Agricultural Land (LTCA/STCA)	Agricultural Land	Individual/HUF
Section 54D	Compulsory Acquisition of Land or Building	Industrial Land or Building	Any Taxpayer
Section 54EE	Any Long Term Capital Asset (LTCA)	Units of notified fund	Any Taxpayer
Section 54GB	Residential house or residential plot of land (LTCA)	Subscription in equity shares of eligible startup	Individual/HUF

Gathering the necessary documents is crucial when dealing with Capital Gains and filing your tax returns. Here’s a rundown of the essential documents you’ll need:

1. PAN (Permanent Account Number): This alphanumeric ID, issued by the Income Tax Department, links all your financial transactions with your income. It’s essential for tax compliance and filing your Income Tax Return (ITR).
2. Aadhaar Card: The 12-digit unique identification number issued by UIDAI is mandatory for Resident Individuals when filing their ITR. It’s another crucial document for tax purposes.
3. Details for Capital Gains Calculation and ITR-2 Filing:
   • Purchase Date
   • Sale Date
   • Period of Holding the Asset
   • Transaction or Brokerage Charges (if applicable)
4. Form 16: Salaried individuals who have had TDS deducted from their salary receive Form 16 from their employer. It provides a detailed statement of the salary earned during the Financial Year, along with deductions, exemptions, and taxes deducted at source.
5. Form 26AS: This is a consolidated Tax Credit Statement that provides various details to taxpayers, including:
   • Taxes deducted from the taxpayer’s income
   • Taxes collected from the taxpayer’s payments
   • Advance Tax, Self-Assessment Tax, and Regular Assessment Taxes paid by the taxpayer
   • Details of refunds received during the year
   • Details of high-value transactions, such as shares and mutual funds
6. Investment Proofs: Certain investments and expenses are eligible for deductions under Chapter VI-A of the Income Tax Act. You’ll need investment proofs to claim these deductions, which can help reduce your taxable income.

Gathering and organizing these documents ensures smooth and accurate tax filing, helping you comply with tax regulations and potentially reduce your tax liability through eligible deductions.

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Official Income Tax Return filing website: https://incometaxindia.gov.in/