Long Term Capital Gains Tax
Capital Gains tax refers to the tax that an individual has to pay for-profit earned from the sale of an asset. There are two types of capital gains – Short-term Capital Gains and Long-Term Capital Gains. Short-term capital gains refer to profit arising from the sale of assets that are held for less than a year. Long-term capital gains tax is levied on the profits of capital assets that held for more than a year. Any investment that is made and held for 1 to 3 years will attract a long-term capital gains tax.
What are Long-Term Capital Gains?
When an individual invests, it is done so keeping in mind the returns that one will eventually get from it. Some investments are supposed to provide returns within a short period and others, which are meant to be held for a few years to provide the best returns. The profits that arise from these long-term investments are known as long-term capital gains. One can invest in products like mutual funds, zero coupons, government bonds, housing property, gold, jewellery, etc.
According to the budget announced on 1st February 2018, Long-term Capital Gains Tax was reintroduced. Earlier, profits arising from the sale of equity-oriented mutual funds or listed equity shares were entirely exempt from long-term capital gains. However, under the latest budget, a 10% tax applies to long-term capital gains exceeding Rs 1 Lakh. Any profit from an investment that is held for a period of 1 to 3 years before selling or transferring it is referred to as long-term capital gains. For example, when a property has been purchased and is sold after five years of its purchase, the revenue earned from the sale will imply long-term capital gains tax.
What is the Tax on Long-Term Capital Gains?
The basic tax on long-term capital gains is 20%. There are additions like education and health cess and other surcharges as well. The government also allows for certain exemptions under special circumstances. If an individual is eligible for such exemptions, then the tax can reduce from 20% to 10%. However, the extra surcharges and taxes will still be applicable.
For example, let us take the case of an individual who has sold a house after five years of purchase and has received a profit of Rs 10 Lakh from the sale. A long-term capital gains tax of 20% applies to the profit along with will a tax and cess of 3%. Therefore, his total tax is to be paid comes to Rs. 2,00,6000.
Exemptions on Long-term Capital Gains Tax
- The income tax department and the government have realized that sometimes the long-term capital gains tax payable can be massive amounts, especially when it comes to things like the sale of a property. Because of this, the government has allowed for certain exemptions to provide relief or to waive off the tax entirely
- In case of property, if the money that is gained from the sale of a property is reinvested into another property within 1 to 3 years of transfer or sale, then the profit is exempt from tax. The profit can also be reinvested into the construction of a new house, which must be completed within three years from the date of sale. That helps to avoid long-term capital gains tax as well. However, it is essential to note that any profit arising from the sale of a property can only be invested in one new asset and cannot be divided into multiple assets to avoid tax. Therefore, a person who sells a property can only reinvest the money into another property
- Capital gains tax does not apply to the sale of rural agricultural land as it is not considered a capital asset in India
- If an amount that is accrued from the sale of a long-term capital asset is reinvested into a Capital Gains Account Scheme, then it will be exempted from the long-term capital gains tax
- In certain cases, mutual fund investments that are for more than one year may not be taxable as per certain asset management companies
- If long-term capital gains are reinvested in certain government bonds such as the National Highway Authority of India or Rural Electrification Corporation, then under section 54EC of the Income Tax Act, up to a maximum amount of Rs 50 Lakh is exempt from any sort of taxation. There is a lock for five years, and a standard rate of interest is generated
How is Long-Term Capital Gains Tax Calculated
One may assume that the calculation of long-term capital gains tax is a relatively straightforward process. For example, one can buy a house at a certain price; sell it after five years for a price that is higher than the purchase price. The positive difference that arises is the long-term capital gains that one has accrued, and tax will be levied on that. However, that is not the case. To calculate long-term capital gains, three components are required: cost of initial investment, the price that it was sold at, and the Cost Inflation Index.
Cost Inflation Index or Indexation is an important process as it adjusts the prices based on a standard index, thereby factoring in any inflation when it comes to profits earned on the sale of assets. An indexation is an essential tool because prices generally do not tend to remain the same over the years, so calculating long-term capital gains based on the original price of a property is not an accurate indication of profit. With indexation, one can come up with an actual original price of the property as per the current market value. This will give a clearer picture of profit earned.
The following steps need to be taken to calculate long-term capital gains tax:
Step 1: Price of Purchase = As per the indexed cost of acquisition based on CII of the year of sale/CII of year of purchase)
Step 2: Actual Profit = Price of Sale – Indexed cost of acquisition
For example, an individual purchased a house at Rs 20 Lakh in 2010. In 2015, he decided to sell the house for Rs 35 Lakh. Now, in this case, let us assume that the indexed cost of acquisition for buying the house was 543, and at the time of sale, it was 667.
Therefore, the indexed cost of acquisition will be: 20,00,000 (667/543) = 24,56,722
Therefore, the actual gain or profit is: 35,00,000 – 24,56,722 = 10,43,278
Table depicting the long-term capital gains tax to be paid as per terms:
|Type of asset||Duration||Tax applicable||Notes|
|Stocks & equity-oriented mutual funds||Sold after one year of purchase||10% of the profit||Tax is applicable only if total long-term profit in a financial year exceeds Rs. 1 lakh|
|Other mutual funds, government bonds, gold, Gold ETF, Privately held stocks||Sold after three years of purchase||10% of profit or 20% of profit after inflation adjustment|
|Property||Sold after three years of purchase||10% of profit or 20% of profit after inflation adjustment||Tax is not applicable if the entire amount is reinvested as per terms in other acceptable assets.|
Ans: According to the Income Tax Act 1961, anyone who has held a capital asset for 1-3 years and then decides to transfer or sell it, earning a profit in the process, is required to pay long-term capital gains tax on the profit. In the case of property sales, the Indexed Cost of Acquisition and Sale is taken into account to balance out any inflation to provide an accurate assessment of the original purchase price.
Ans: Capital assets that are held for 1-3 years and then sold attract long-term capital gains tax. This includes things like stocks, shares, bonds, mutual funds, gold, jewellery, and housing property.
Q: Can I reinvest my profit earned from the sale of my house into another property and the balance into a mutual fund?Ans: To avoid paying long-term capital gains tax, the entire amount accrued from the sale of a property must be reinvested into another property within 1-2 years from the date of sale, or it was must be invested into the construction of a house within three years from the date of sale. It is not allowed to invest profits into multiple investment products.
Ans: If any capital assets are sold before 1 to 3 years, then they do not qualify for long-term capital gains tax. Instead, one would have to pay short-term capital gains tax as per its terms.
Q: If I sell my house in India and want to reinvest that money into a property in another country, am I still exempt from Long Term Capital Gains Tax?Ans: No. Exemptions for long-term capital gains tax are only applicable for properties that are based in India.