Capital gains meaning is the period an asset is held. Gains from investments can be categorised into two types:
- Short-term capital gain
Profit from selling an asset within 36 months of its acquisition is called short-term capital gains. For example, selling a property within 24 months of purchase. However, the holding duration varies for different assets. For Mutual Funds and listed shares, if the asset is held for more than 1 year, it qualifies as a long-term gain.
- Long-term capital gain
If an asset is sold after 36 months of acquisition, the resulting profit is called long-term capital gains. In 2017, the holding period for non-moveable properties was reduced to 24 months. This rule, however, does not apply to movable assets like debt-oriented Mutual Funds or jewellery. Moreover, certain assets, including securities, equity shares, zero-coupon bonds and UTI units are considered long-term if held for 12 months or more. In cases of gifted assets or inheritance, the ownership period of the previous owner is considered.
It is important to understand what is capital gains in the context of market capitalisation because it impacts the valuation of assets and influences investment decisions in the financial markets.
The following is a duration chart of income generated against the sale of assets:
| The asset type |
Long-term period |
Short-term period |
| Listed shares |
>1 year |
<1 year |
| Debt oriented mutual funds |
>3 years |
<3 years |
| Movable properties (e.g. jewellery) |
>3 years |
<3 years |
| Immovable assets (e.g. landed property.) |
>2years |
<2 years |
| Equity oriented mutual funds |
>1 year |
<1 years |
How to calculate capital gains?
Calculating capital gains is important to understand capital asset pricing model, and it mainly depends on the kind of assets and how long they have been held. Before we dive into the computations, let us look at some important key terms:
- Cost of improvement: The amount of expenses sustained by a seller in making any alterations or additions to a capital asset is known as cost of improvement.
- Full value consideration: When the total amount is received by a seller in exchange for a capital asset it is called full value consideration.
- Cost of acquisition: The value of an asset at the time a seller acquires it is known as cost of acquisition.
To understand the capital gain definition and calculate the value of short-term capital gains, we need to start by determining the full consideration received. The cost of improvement, cost of acquisition and the total expenditure incurred related to the transfer of ownership have to be subtracted from this figure. The capital gain on investments is represented by the remaining amount.
- Indexed cost of improvement: By multiplying the associated cost of improvement that was required to the CII (Cost Inflation Index) of the year divided by the CII of the year in which the improvement occurred, the indexed cost of the improvement is calculated.
- Indexed cost of acquisition: Likewise, the cost of acquisition is calculated on the present terms by applying the CII, which is done to adjust for inflation. To estimate indexed cost, the cost of acquisition is multiplied by the ratio of the CII of the year the asset was acquired or the fiscal year 2001–2002, whichever is later, to that of the year of sale.
Suppose a person acquired an asset for Rs. 40 Lakh in the financial year 2006–2007 and then decided to sell it in 2017–18, and had CIIs of 105 and 265, respectively, then the indexed cost of acquisition would be 40 * 265/105 = Rs. 100.95 Lakh.
What are the tax exemptions on capital gains?
The following sections for profits earned from assets can help avail tax exemptions:
Section 54EC
Under Section 54EC, tax exemptions are applicable if capital gains are invested in specific bonds after a property is sold. After 3 years from the sale date, the invested amount can be redeemed; however, the bonds cannot be sold within this duration. Note that the investment in these bonds must be made within 6 months of selling the property.
Section 54
Capital gains are exempt from tax when proceeds from selling a residential property are reinvested in another property. However, this applies only if an individual meets the following conditions:
They purchased a second property 1 year prior or within 2 years of the sale.
They fulfilled the purchase of an under-construction property within 3 years of selling the first property.
They do not sell the newly acquired property within 3 years of purchase.
They have ensured the property is located in India.
Section 54F
Capital gains from long-term assets other than residential properties can be exempted under Section 54F. However, if the new asset, such as equity share capital, is sold within 3 years of purchase or construction, the exemption is invalidated. Additionally, the construction should be completed within 3 years from the sale date or the purchase of a new property should happen within 2 years of earning the capital.
Changes in regulations related to capital gains on shares in the Union Budget 2024
Following were some of the important changes in regulations related to capital gains on shares in Union Budget 2024-
- Standardisation of holding periods: The holding period for all listed securities has been unified at 12 months. Securities held for more than 12 months will be classified as long-term. For other assets, the holding period remains at 24 months.
- Simplified classification: The budget has eliminated the previous 36-month holding period, streamlining the classification of assets into long-term and short-term categories.
- Increased exemption limit for long-term capital gains: To provide tax relief to lower and middle-income earners, the exemption limit for long-term capital gains on shares, equity-oriented units, and business trust units has been increased from Rs. 1 lakh to Rs. 1.25 lakh per year.
- Revised tax rates: While the exemption limit has been raised, the capital gains tax rate for long-term gains has increased from 10% to 12.5%. Short-term capital gains tax on shares, equity-oriented funds, and business trust units has been elevated from 15% to 20%.
Concluding thoughts
Capital gains means profits from selling investments like bonds, stocks or real estate. They are taxed at a lower rate than ordinary income, providing investors an advantage. Moreover, capital losses can sometimes offset taxable income. Thus, it is imperative that you understand capital gains taxes to optimise your financial strategies.
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