What are Capital Gains?

Introduction

Capital gains are the profits that are realized by selling an asset, such as stocks, bonds, or real estate. Capital gains are generally associated with investments, due to their inherent price volatility. Capital gains are taxed differently depending on how long you hold the asset before selling it. Short-term capital gains are taxed at your ordinary income tax rate, while long-term capital gains are taxed at a lower rate, depending on your income bracket. There are also some exemptions and deductions available for certain types of capital gains, such as those from the sale of a house property.

Some additional information that you might find useful are:

Capital assets are any type of asset you own, such as land, building, house property, vehicles, patents, trademarks, etc.
The difference between the sale price and the original purchase price of the asset is called the capital gain or loss.
Capital gains can be either realized or unrealized. Realized capital gains occur when you sell the asset, while unrealized capital gains reflect the increase in the value of the asset without selling it.
Capital gains can be offset by capital losses, which reduce your taxable income. You can also carry forward your capital losses to future years, subject to certain limitations.
Capital gains are calculated differently for different types of assets, such as equity shares, mutual funds, debt instruments, gold, etc. You should consult a tax professional or use a tax calculator to determine your exact tax liability.

Understanding Capital Gains

Capital gains are the profits that you make when you sell an asset that has increased in value. Capital gains can apply to any type of asset, such as stocks, bonds, real estate, or even personal items. Capital gains are taxed differently depending on how long you hold the asset before selling it. In India, there are two types of capital gains: short-term and long-term.

Short-term capital gains (STCG) are the gains from selling an asset that you have held for one year or less. STCG are taxed at your normal income tax rate, which can range from 5% to 30%, depending on your income slab.
Long-term capital gains (LTCG) are the gains from selling an asset that you have held for more than one year. LTCG are taxed at a lower rate of 20%, with some indexation benefit. Indexation is a method of adjusting the purchase price of the asset according to inflation, which reduces the taxable gain amount.

There are also some exemptions and deductions available for certain types of capital gains, such as those from the sale of a house property, agricultural land, or equity shares. You can also offset your capital gains with capital losses, which are the losses from selling an asset that has decreased in value. Capital losses can be carried forward for up to eight years, subject to certain conditions.

To calculate your capital gains, you need to subtract the original purchase price of the asset from the sale price. You also need to factor in any expenses related to the sale, such as brokerage fees, stamp duty, or legal charges. For example, if you bought a house for Rs. 50 lakhs in 2018 and sold it for Rs. 70 lakhs in 2023, your capital gain would be Rs. 20 lakhs. However, if you spent Rs. 1 lakh on brokerage and Rs. 50,000 on stamp duty, your net capital gain would be Rs. 18.5 lakhs. This would be a long-term capital gain, since you held the asset for more than one year. You can also apply indexation to the purchase price, which would reduce the taxable gain amount further.

Types of Capital Assets

Capital assets are any type of asset that you own or control, such as land, building, house property, vehicles, patents, trademarks, etc. Capital assets can be classified into different types based on their convertibility, physical existence, and usage. Here are some of the common types of capital assets:

Current assets: These are liquid assets that can be easily converted into cash or its equivalent within a year, such as cash, cash equivalents, accounts receivables, inventories, etc.
Noncurrent or fixed assets: These are long-term assets that are used for more than a year, such as property, machinery, equipment, long-term investments, patents, trademarks, goodwill, etc.
Tangible assets: These are assets that have a physical form and can be measured, such as cash, property, raw material, equipment, office supplies, tools, etc.
Intangible assets: These are assets that do not have a physical form but have monetary value and contribute to the operation of the business, such as brands, patents, copyrights, trademarks, licenses, permits, stocks, royalties, goodwill, etc¹.
Operating assets: These are assets that are required for the primary operations of the business, such as production, sale, or service, such as cash, inventory, machinery, building, patent, copyright, plant, etc.
Non-operating assets: These are assets that are not used in the day-to-day operations but are accumulated for future use, such as land that is not used, marketable securities, short-term investments, interest income from fixed deposits, etc.

Classification of inherited Capital Assets

Inherited capital assets are those assets that are acquired by gift, will, succession, or inheritance from a previous owner. The classification of inherited capital assets depends on the type and the holding period of the asset. The type of the asset determines whether it is a short-term or a long-term capital asset based on the duration for which it is held by the current owner and the previous owner. The holding period of the asset affects the tax rate and the indexation benefit applicable on the capital gains arising from the sale of the asset.

The following table summarizes the classification of inherited capital assets based on the type and the holding period of the asset:

Table

Type of Asset	Holding Period	Classification
Listed securities, units of equity-oriented funds, units of UTI, zero coupon bonds	More than 12 months	Long-term capital asset
Listed securities, units of equity-oriented funds, units of UTI, zero coupon bonds	Less than or equal to 12 months	Short-term capital asset
Unlisted shares	More than 24 months	Long-term capital asset
Unlisted shares	Less than or equal to 24 months	Short-term capital asset
Immovable property (land or building or both)	More than 24 months	Long-term capital asset
Immovable property (land or building or both)	Less than or equal to 24 months	Short-term capital asset
Any other asset	More than 36 months	Long-term capital asset
Any other asset	Less than or equal to 36 months	Short-term capital asset

Tax Rates : Long-Term Capital Gains and Short-Term Capital Gains

Capital gains are profits or gains arising from the transfer of a capital asset, such as land, building, house property, vehicles, patents, trademarks, etc. Capital gains are classified as short-term or long-term depending on the period of holding of the asset.

Short-term capital gains (STCG) are gains from the sale of an asset that is held for less than 36 months (except for some assets like shares, mutual funds, etc., where the period is 12 months). STCG are taxed as ordinary income according to the relevant income tax slab rate of the taxpayer.

Long-term capital gains (LTCG) are gains from the sale of an asset that is held for more than 36 months (or 12 months for some assets). LTCG are taxed at a concessional rate of 20% (plus surcharge and cess) with the benefit of indexation. Indexation is a method of adjusting the cost of acquisition of the asset with respect to inflation, which reduces the taxable amount of capital gains.

There are some exceptions and exemptions to the above rules, such as:

LTCG from the sale of equity shares and equity-oriented mutual funds are taxed at 10% (plus surcharge and cess) without indexation, if the securities transaction tax (STT) is paid. However, LTCG up to Rs. 1 lakh in a financial year are exempt from tax.
STCG from the sale of equity shares and equity-oriented mutual funds are taxed at 15% (plus surcharge and cess), if the STT is paid.
LTCG from the sale of a residential house property are exempt from tax if the taxpayer invests the net sale proceeds in another residential house property within the specified time limit, subject to certain conditions.
LTCG from the sale of any capital asset (other than a residential house property) are exempt from tax if the taxpayer invests the net sale proceeds in a residential house property within the specified time limit, subject to certain conditions and a maximum limit of Rs. 50 lakhs.
LTCG from the sale of any capital asset are exempt from tax if the taxpayer invests the net sale proceeds in specified bonds issued by the National Highways Authority of India (NHAI) or the Rural Electrification Corporation (REC) within the specified time limit, subject to certain conditions and a maximum limit of Rs. 50 lakhs.

How Do Mutual Funds Account for Capital Gains?

Mutual funds account for capital gains by distributing them to their investors at the end of the year. Capital gains are the profits made by the fund from selling the securities it holds. Capital gains distributions are taxable to the investors, unless they hold the fund in a tax-deferred account.

The tax rate on capital gains depends on the type of mutual fund and the holding period of the investor. There are two types of capital gains: short-term and long-term. Short-term capital gains are from securities held for less than a year, and are taxed at the same rate as ordinary income. Long-term capital gains are from securities held for more than a year, and are taxed at a lower rate than ordinary income.

The type of mutual fund also affects the tax rate on capital gains. Equity-oriented mutual funds, which invest mostly in stocks, have a lower tax rate on long-term capital gains than debt-oriented mutual funds, which invest mostly in bonds. Equity-oriented mutual funds also have an exemption for long-term capital gains up to Rs. 1 lakh in a financial year.

To calculate the capital gains tax on mutual funds, you need to know the following information:

The type of mutual fund (equity or debt)
The holding period of the mutual fund units (short-term or long-term)
The cost of acquisition of the mutual fund units
The sale price of the mutual fund units
The indexation factor (if applicable)

The cost of acquisition is the amount you paid to buy the mutual fund units. The sale price is the amount you received when you sold or redeemed the mutual fund units. The indexation factor is a method of adjusting the cost of acquisition for inflation, which reduces the taxable amount of capital gains. Indexation is applicable only for long-term capital gains on debt-oriented mutual funds.

The formula for calculating the capital gains tax on mutual funds is as follows:

For short-term capital gains: Tax = (Sale price – Cost of acquisition) x Tax rate
For long-term capital gains: Tax = (Sale price – Indexed cost of acquisition) x Tax rate

The indexed cost of acquisition is calculated by multiplying the cost of acquisition with the indexation factor. The indexation factor is the ratio of the cost inflation index (CII) of the year of sale to the CII of the year of purchase. The CII is a number that reflects the inflation rate in India, and is notified by the government every year.

The tax rates for different types of mutual funds and holding periods are as follows:

For equity-oriented mutual funds:
- Short-term capital gains: 15% (plus surcharge and cess)
- Long-term capital gains: 10% (plus surcharge and cess) on gains exceeding Rs. 1 lakh, without indexation
For debt-oriented mutual funds:
- Short-term capital gains: As per the income tax slab rate of the investor
- Long-term capital gains: 20% (plus surcharge and cess) with indexation