When you sell stocks, mutual funds, or real estate after holding them for over one year, you will be subject to long-term capital gains (LTCG) tax. On the other hand, if you sell these assets within one year of purchasing them, you will be liable to pay short-term capital gains (STCG) tax
When you sell mutual funds, you might need to pay capital gains tax on the profit. This tax depends on the difference between the buying price and selling price of the investment. Also, how long you held the investment determines the tax rate. This article will explain short-term and long-term capital gains tax differences and share tips on reducing your tax liability.
Capital gain arising on sale of short-term capital asset is termed as short-term capital gain and capital gain arising on transfer of long-term capital asset is termed as long-term capital gain. However, there are a few exceptions to this rule, like gain on depreciable asset is always taxed as short-term capital gain.
In this article, we delve into the distinctions between short-term and long-term capital gains tax, exploring how each impacts investors and their financial strategies. By gaining a comprehensive understanding of these tax considerations, investors can make informed decisions to optimize their investment returns while remaining compliant with tax regulations.
What are short-term capital gains?
- Definition: These arise from selling a capital asset held for one year or less (holding period).
- Taxation: Short term capital gains tax (LTCG) in India is charged at a rate of 20% equity mutual funds held for less than a year. On debt funds, short term capital gains also 20%.
- Impact: Short-term gains can significantly impact your tax bill, especially for high earners.
What are long-term capital gains?
- Definition: These occur from selling a capital asset held for more than one year (holding period varies by asset class in some countries).
- Taxation: Long term capital gains tax (LTCG) in India is charged at a rate of 12.5% on stocks and equity mutual funds held for over a year. While on debt funds LTCG is levied at a rate of 12.5% on units held for more than 36 months.
- Benefits: The lower tax rates on long-term gains incentivise long-term investing, allowing your investments to grow potentially with a smaller tax burden when you sell.
New tax rates announced in Budget 2024
In the Union Budget 2024, taxes on long-term (LTCG) and short-term capital gains (STCG) have been increased. Now, the tax rate for STCG arising from equity investments is set at 20% (up from the previous rate of 15%), whereas all the other assets will be taxed as per the slab rate applicable to the taxpayer.
When it comes to LTCG, a flat rate of 12.5% has been announced. This rate will be applicable only if your LTCG exceeds the Rs. 1,25,000 threshold limit (up from the previous limit of Rs. 1,00,000).
Also, the period for non-financial assets to qualify as LTCG has been brought down to 2 years (24 months). Although the LTCG rate on the sale of land, gold, and unlisted shares has been lowered to 12.5% from 20%, indexation benefits have been removed.
Among other market-impacting announcements, the budget revealed a significant hike in the Securities Transaction Tax (STT) rate. It was increased from 0.01 percent to 0.02 percent. This increase will effectively double the tax burden for equity and index traders involved in Futures and Options (F&O) transactions.
Furthermore, in a significant relief for taxpayers, the period for reassessment and reopening of returns filed for earlier years has been reduced to 6 years (down from the previous 10 years). This also includes search cases.
Difference between short-term and long-term capital gains tax
Profits you make from selling assets you have held for a year or less are called short-term capital gains. Alternatively, gains from assets you have held for longer than a year are known as long-term capital gains.
Parameters |
Short-term gains |
Long-term gains |
Holding period for equity mutual funds |
Tax is applicable if the holding period is less than or equal to 1 year |
Tax is applicable if the holding period is more than 1 year |
Applicable tax rate for equity mutual funds |
20% |
12.5% over and above Rs. 1.25 lakh without indexation |
Holding period for debt mutual funds |
Tax is applicable if the holding period is less than or equal to 36 months |
Tax is applicable if the holding period is more than 36 months |
Applicable tax rate for debt mutual funds |
As per the income tax slab |
20% after indexation |
Current holding period rules - Short-term vs Long-term capital gains
Type of asset (STCG) |
Holding period for STCG |
Holding period for LTCG |
Listed equity shares |
12 months or less |
More than 12 months |
Equity-oriented mutual fund units |
12 months or less |
More than 12 months |
Unlisted equity shares (including foreign shares) |
24 months or less |
More than 24 months |
Immovable assets (i.e., house, land and building) |
24 months or less |
More than 24 months |
Movable assets (such as gold, silver, paintings etc.) |
24 months or less |
More than 24 months |
Budget 2024 new tax rates - Short-term vs. long-term capital gains
Type of asset |
STCG tax rate |
LTCG tax rate |
Listed equity shares |
20% |
12.5% (no indexation benefit; exempted up to Rs. 1.25 lakh in an FY) |
Equity-oriented mutual fund units |
20% |
12.5% (no indexation benefit; exempted up to Rs. 1.25 lakh in an FY) |
Unlisted equity shares (including foreign shares) |
Income tax slab rate applicable to taxpayer income |
12.5% (without any benefit of indexation) |
Immovable assets (i.e., house, land and building) |
Income tax slab rate applicable to taxpayer income |
12.5% (without any benefit of indexation) |
Movable assets (such as gold, silver, paintings etc.) |
Income tax slab rate applicable to taxpayer income |
12.5% (without any benefit of indexation) |
How to calculate your capital gains after Budget 2024’s tax hike
In the Union Budget 2024, the tax rate applicable to STCG from equity investments has been hiked from 15% to 20%. Meanwhile, the LTCG tax rate has increased from 10% to 12.5% for all capital assets. To easily calculate your capital gains after these announcements/changes, follow these simple steps:
- For Long-Term Capital Gains (LTCG)
- Record the total amount obtained from selling the asset.
- Subtract any expenses directly related to the transfer of the asset.
- Adjust the original purchase price for inflation and subtract this amount.
- Adjust the cost of any improvements for inflation and subtract this amount.
- Subtract any exemptions available under Sections 54, 54D, 54EC, 54F, and 54B.
- The remaining amount is your long-term capital gain, which will be taxed.
- For Short-Term Capital Gains (STCG)
- Record the full amount received from selling the asset.
- Subtract any costs directly associated with the sale.
- Subtract the original purchase price of the asset.
- Subtract the costs of any improvements made to the asset.
- Subtract any exemptions allowed under Sections 54B and 54D.
- The remaining amount is your short-term capital gain, which will be taxed.
Also read: How to calculate capital gains tax on mutual funds
Tax on equity and debt mutual funds
The taxation of gains from the sale of debt and equity funds varies. A fund is classified as an equity fund if it allocates more than 65% of its portfolio to equities. Below is a table illustrating the tax treatment of these gains before and after 1 April 2023:
Funds |
On or before 1 April 2023 |
Effective 1 April 2023 |
|
Short-Term Gains |
Long-Term Gains |
Debt Funds |
Taxed at individual slab rates |
10% (without indexation) or 20% (with indexation), whichever is lower |
Equity Funds |
15% |
10% (for gains exceeding ₹1 lakh, without indexation) |
Capital gains tax strategies to reduce the tax burden
Selling investments for a profit can trigger capital gains taxes. This guide explores smart strategies to minimise your tax burden and maximise your after-tax returns:
- Holding an equity investment for a longer period: Holding an equity investment for over a year can help get long-term capital gains tax benefits, which is usually lower than the short-term capital gains tax. For debt mutual funds it is different, you must hold it for at least 36 months (about 3 years) to qualify as a long-term capital gain tax.
- Tax loss harvesting: Selling an unprofitable asset at a loss and buying another profitable asset can help offset capital gains from profitable trades, which reduces the overall tax liability.
- Opting for dividend re-investment scheme: Instead of taking the dividend payout, investors can reinvest dividends to purchase additional shares, which may reduce the tax liability.
- Careful selection of mutual funds: Choosing mutual funds that have longer durations, higher credit risks, or credit opportunities can lead to higher tax-adjusted returns than those with shorter durations.
- Indexation for long-term debt mutual fund investments: Indexation is a method for calculating the cost of an asset after adjusting for inflation to reduce the tax liability on long-term debts.
Common misconceptions about capital gains tax in mutual funds
Listed below are some common misconceptions about capital gains tax in mutual funds:
- Myth: Switching between schemes is not taxable
Fact: Every time an investor switches between Financial Institutions or schemes within a mutual fund, it is considered a sale/purchase of units in the fund. That means even if one switches from one mutual fund scheme to another of the same fund house, it is treated as selling and buying again, causing capital gains or losses to arise. - Myth: Mutual fund gains are taxed at a fixed rate.
Fact: Taxation varies based on the holding period. Short-term gains and long-term gains tax is levied on mutual funds based on the holding time.
How are STCG and LTCG determined
Tax implications can significantly impact your investment returns. Understanding the distinction between short-term capital gains (STCG) and long-term capital gains (LTCG) is crucial for making informed investment decisions.
The primary factor determining STCG vs. LTCG is the holding period. This refers to the length of time you hold an investment before selling it. Generally, assets held for less than one year are considered STCG, while those held for more than one year fall under LTCG.
It is important to note that specific asset classes might have different holding period requirements. For instance, real estate may have a shorter holding period for LTCG treatment compared to stocks or bonds.
Conclusion
Understanding the difference between short-term capital gains (STCG) and long-term capital gains (LTCG) is crucial for mutual fund investors. STCG, from selling units held less than the defined holding period, are taxed at your ordinary income tax rate. Conversely, LTCG, from selling units held beyond the holding period, benefit from potentially lower tax rates. By strategically holding your mutual fund units and considering tax implications, you can optimise your returns and minimise your tax burden. Remember, consulting a financial advisor can help tailor investment strategies to your specific tax situation and financial goals.
