In India, capital gains refer to the profit made from the sale of a capital asset such as property, shares, or bonds. There are two types of capital gains in India: short-term capital gains (STCG) and long-term capital gains (LTCG).
Short-term capital gains (STCG) arise when a capital asset is sold within 36 months (for immovable property) or 12 months (for other capital assets) from the date of purchase. For STCG, the gain is taxed as per the applicable tax slab rate for the financial year in which the asset was sold.
Long-term capital gains (LTCG) arise when a capital asset is sold after 36 months (for immovable property) or 12 months (for other capital assets) from the date of purchase. LTCG on equity shares and mutual funds held for more than a year are taxed at a flat rate of 10% without any indexation benefit.
For example, if an individual sold a property after 2 years of purchase for a profit of Rs 1,00,000, it would be considered as LTCG and taxed at 10% (Rs 10,000). If the same property was sold after 11 months of purchase for the same profit, it would be considered as STCG and taxed as per the applicable tax slab rate for that financial year.
It is important to note that the tax implications for STCG and LTCG can change from year to year based on the changes in tax laws. Hence, it is advisable to consult a tax expert to understand the applicable tax implications for capital gains in a given financial year.
Capital gains can be optimized using various investment strategies:
- Long-term investments: By holding onto a capital asset for a longer period, the gains can be categorized as LTCG, which attracts a lower tax rate compared to STCG.
- Investing in tax-saving instruments: Certain investments such as Equity-Linked Saving Schemes (ELSS) or bonds offered by the National Highways Authority of India (NHAI) or Rural Electrification Corporation (REC) provide tax benefits under section 80C of the Income Tax Act. This can help reduce the tax liability on capital gains.
- Using the indexed cost of acquisition: The indexed cost of acquisition is used to account for inflation and is calculated as the original cost of acquisition adjusted for the Cost Inflation Index (CII) issued by the government. This helps to reduce the tax liability on long-term capital gains as the indexed cost of acquisition is higher than the original cost.
- Opting for Capital Gain Bonds: Capital Gain Bonds issued by NHAI and REC under section 54EC of the Income Tax Act can be used to invest the capital gains and defer the tax liability.
- Selling loss-making investments: If an individual has both short-term and long-term capital gains and losses, the losses can be set off against the gains to reduce the tax liability.
It is advisable to consult a financial advisor or a tax expert to understand the best investment strategies to optimize capital gains, as the strategies will vary based on the individual’s specific financial situation and tax liability.
Here is an example of how Raman used his investments wisely to reduce both his long-term and short-term capital gains:
- Long-term capital gains: Raman invested in Equity-Linked Saving Schemes (ELSS) for 5 years. When he sold his ELSS units, he categorized the gains as LTCG, which attracted a lower tax rate of 10% as compared to his applicable tax slab rate. This helped Raman reduce his tax liability on capital gains.
- Short-term capital gains: Raman had short-term capital gains from the sale of some mutual fund units. He reinvested these gains in capital gain bonds offered by the National Highways Authority of India (NHAI) under section 54EC of the Income Tax Act. This helped him defer the payment of tax on the short-term capital gains and reduced his overall tax liability.
- Loss-making investments: Raman had losses from some of his stock investments. He set off these losses against his short-term capital gains, which helped him reduce his tax liability on capital gains.
By using these strategies, Raman was able to optimize his capital gains and reduce his tax liability effectively. It is important to note that the above strategies will vary based on the individual’s specific financial situation and tax laws, and it is always advisable to consult a financial advisor or tax expert for personalized advice.