What Is Capital Gains Tax?

What is capital gains tax?

Capital gains is the tax you pay on the profit you make on selling an asset. These assets can include stocks, bonds, digital assets like cryptocurrencies and NFTs, jewelry, coins, and real estate, etc. In other words, when you sell an asset at a price higher than the purchase price, you make some profit due to this difference in price. We call this profit as capital gain, and the tax levied on it is capital gains tax.

It is important to note here that capital gains tax is applicable only on the profit made and not on the entire value of the asset or investment. The rate of this tax varies depending on the period of holding the asset. The assets on which this tax is levied are called capital assets. Let us know which items come under the purview of capital asset.

What are capital assets?

• Capital assets include property and goods that you own and that ownership can be transferred. These include:
• Real Estate: Land and land-related assets such as houses, shops or agriculture and industries are major capital assets.
• Equity Shares: When we buy shares or shares of a company, they also come under the category of capital asset.
• Gold: Gold and coins made of gold, jewellery, idols etc. are also capital assets.
• Antiques and artwork: Antiques or artwork are also considered capital assets.
• Fixed Deposits (FD) and Bonds: FDs, bonds and debentures etc. are also capital assets.

For businesses, a capital asset is property that has a useful life of more than one year and is not planned to be sold in the course of day-to-day business operations. For example, if a company buys a computer for its office, that computer is its capital asset. Similarly, if another company buys the same computer to sell, it will be counted in the inventory.

Capital assets can be tangible and intangible. Most capital assets include buildings, land, houses etc., and these are tangible capital assets because they can be seen and touched. Whereas trademarks, brand values, etc. come under the category of intangible assets because they can neither be seen nor touched.

How many types of capital assets are there?

We can mainly divide capital assets into two parts:

• Short term capital asset and long term capital asset

Short Term Capital Assets: Short term capital assets are those assets which we hold for a short period of 24 to 36 months. This holding period may vary depending on the type of asset. For example, if the asset is any property, land or property which we sell before 24 months, then it will fall in the category of short term capital asset.

Similarly, if equity shares or equity related instruments of a company are encashed before 12 months and debt mutual funds which are sold before 36 months, they also come under short term capital assets.

• Long Term Capital Asset

Assets which are sold after 12 to 36 months are called long term capital assets. As mentioned above, if a property is sold after 24 months, stocks or equity mutual funds which are sold after 12 months and debt bonds and mutual funds which are sold after 36 months are counted as long term capital assets.

How many types of capital gains tax are there?

Capital gain is capital like asset. Capital gain tax is also of two types:

Short-term capital gains tax: Short-term capital gains tax is levied on profits made on assets that are sold within 12 months. Here it must be noted that it is not necessary that this time period be only of 12 months. This time period may be different for different capital assets.

Long Term Capital Gain Tax: When we hold a capital asset for a maximum of 3 years and then sell it, the tax levied on it is called Long Term Capital Gain. Here also it is important to keep in mind that the time period for capital gain calculation may be different for different assets.

The applicable capital gains tax as per the holding period of the capital asset is shown in the table below.

Capital Asset	Holding period for Short term capital gains tax	Holding period for Long term capital gains tax
Debt Mutual Funds	Less then 36 months	More then 36 months
Equity Mutual Funds	Less then 12 months	More then 12 months
Listed Equity Shares	Less then 12 months	More then 12 months
Unlisted Equity Shares	Less then 24 months	More then 24 months
Immovable Property	Less then 24 months	More then 24 months
Movable Property	Less then 36 months	More then 36 months
ULIP	Less then 12 months	More then 12 months
Government and Corporate Bonds	Less then 36 months	More then 36 months
Gold	Less then 36 months	More then 36 months
Gold ETF	Less then 12 months	More then 12 months

How is capital gains tax calculated?

The calculation of capital gains tax depends on the capital asset and the short term or long term tax applicable on it. Tax will also be calculated according to the type of capital asset. The following values are taken into account to calculate capital gains tax.

Full Value: Full value is the amount you get when you transfer your capital asset to another party. That means, if you have sold a capital asset for Rs 10 lakh, then that Rs 10 lakh will be the full value of that asset.

Cost of Acquisition: The price at which you purchased the asset. According to the above example, if you bought an asset for Rs 5 lakh, and after some time sold it for Rs 10 lakh, then Rs 5 lakh will be called the cost of acquisition of that asset.

Cost of Improvement: The amount spent by you on improving an asset after purchasing it is called cost of improvement. If any improvement cost is incurred before April 2001, it is not included in the cost of Acquisition to calculate capital gain.

Asset transfer expense: Asset transfer expense includes the expenses incurred to transfer the ownership of an asset to another party. For example, house registry, broker’s fees etc.

Cost of inflation: Inflation means inflation. Inflation increases year after year, due to which the value of money decreases. Similarly, if you hold any asset and sell it after a long time, then inflation cost also has to be included in the profit.

After knowing all the above mentioned things, you can calculate the capital gain, according to which tax is applicable.

To calculate short term capital gain:

Full value

–  Asset transfer cost

–  Cost of Aquisition

–  Cost of improvement

To calculate long term capital gain:

Full value

–  Asset transfer cost

–  Indexed Cost of Aquisition

–  Indexed Cost of improvement

– Exemptions covered under Section 54, Section 54EC etc.

Capital gains tax rate

Capital Asset	Short term capital gains tax	Long term capital gains tax
Debt Mutual Funds	As per Income Tax Slab	20% with indexation
Equity Mutual Funds	15% of gains	10% over and above 1 Lakh
Listed Equity Shares	15% of gains	10% over and above 1 Lakh
Unlisted Equity Shares	As per Income Tax Slab	20% with indexation
Immovable Property	As per Income Tax Slab	20% with indexation
Movable Property	As per Income Tax Slab	20% with indexation
ULIP	15% of gains	10% over and above 1 Lakh
Government and Corporate Bonds	As per Income Tax Slab	20% with indexation
Gold	As per Income Tax Slab	20% with indexation
Gold ETF	As per Income Tax Slab	10% over and above 1 Lakh

Capital gains tax exemptions

Due to capital gains tax, we have to deposit a large part of our profit as tax to the government. To save our tax, we can claim exemption in tax under many sections of income tax. These are called capital gains tax exemptions, which are explained below:

Section 54: Exception to Section 54 is applicable in cases where the money received from sale of a house is invested in the purchase or construction of another house or property. From the Budget 2014-15, the exemption under this section has been limited to the purchase of one house only, and this exemption can be availed by the taxpayer only once in his lifetime, provided the capital gain limit should not exceed Rs 2 crore. . For this exemption the following conditions have to be fulfilled:

• The taxpayer has to invest only the amount of capital gain, if the amount invested out is more than the capital gain, then the exemption is limited to the amount of capital gain only.
• The new property can be purchased 1 year before the old sold property or 2 years after the sold property.
• If the capital gain money is invested in the construction of a new house, then the construction should be completed within 3 years of the sale.
• If the new property purchased or constructed is sold within 3 years, the exemption can be withdrawn.

Section 54F: Exemption under Section 54F applies to long-term capital gains arising from sale of property other than house. Unlike Section 54, to claim this exemption, you have to invest the entire amount received from selling the property in the purchase of a new property. To claim it you need to:

• Investment has to be made 1 year before the sale or 2 years after the sale.
• If the money is invested in the construction of a property, it should be completed within 3 years of the sale.
• To be eligible for the exemption, the sale proceeds can only be invested in a property or its construction, and if the property is sold before 3 years, the exemption can be withdrawn.

Section 54EC: To avail exemption under this section, the long term capital gain arising from sale of long term asset has to be invested in 54EC bonds which are also called capital gain bonds. According to this :

• The property sale proceeds should be invested in capital gains bonds issued by REC, PFC or NHAI. This investment can be made up to a limit of Rs 50 lakh.
• The maturity period of these bonds is 5 years, and every year you are paid a fixed interest on the investment amount.
• The profit or capital gain from sale of property has to be invested in Capital Gain Bond within 6 months before ITR filling.

Section 54B: This exemption covers long or short-term capital gains arising from sale of land used for farming. This land should be used for farming for at least 2 years. The amount received from sale should be reinvested in some other agricultural land within two years of sale.

Section 54D: Capital gain arising from sale of land which is used for industrial purposes. To take advantage of this:

• The capital gain amount should be used only for the purchase of industrial property or building.
• The land or bidding being sold should have been used for industrial or business purposes for two years before the transfer.
• The funds received after selling or transferring the property should be invested in a new property within 3 years.
• If the price of the new property is more than or equal to the sale price, tax exemption is applicable on all capital gains.
• If the value of the new asset is less than the amount of capital gain, then only the capital gain equal to the value of the newly purchased property will qualify for tax exemption.

Conclusion

Capital gains tax is an important part of the Indian taxation system. If you have made any capital gain or profit on selling any asset then it becomes necessary to include it in ITR. Most capital gains or losses are reported in ITR2 or ITR3, and you can also claim exemptions under various sections of income tax. To take full advantage of these exemptions, you need to know the asset’s holding period and tax rate, or you can make better financial planning decisions by taking help from a finance professional.