PROSPERR.IO

A capital gain when an investment is sold will get you a profit. There are lots of different kinds of investments that will earn you a capital gain when sold. For example, you could sell shares, you may sell mutual funds, real estate or jewellery for a capital gain. However, capital gains are different when it comes to how you will be taxed. When you pay your taxes, there are two types of capital gains under the Income-Tax Act: short-term capital gains (STCG) and long-term capital gains (LTCG). You should know if you have a STCG or LTCG gain, as this will help with your financial planning.

How short-term capital gain(s) and long-term capital gain(s) affect:

• Tax Rate - Short-term capital gain(s) will incur a higher tax than long-term capital gain(s).
• Indexation Benefit - Certain long-term capital gain(s) on some assets will give you an indexation adjustment and result in a smaller taxable profit.
• Tax Exemption - Many capital gain exemptions only apply to long-term capital gains.
• Set Off's/ Carry Forwards - The classification of the gain will determine how the capital gain(s) will reduce other types of income from your taxes.
  

For example, if you were to sell a publicly traded company for less than 12 months, you will have a short-term capital gain. However, if you hold that same publicly traded share for more than 12 months you will have long-term capital gain. Long term capital gains provide a better taxation treatment than short-term capital gains.

There are already large differences between the two types of gains, even a minor difference can be very important for you when selling your investment(s).

Because of these differences, even a small change in the holding period, sometimes by just a few days can significantly alter your tax liability.

This makes it essential for investors, property owners, and taxpayers to clearly understand:

• What qualifies as a capital asset
• How holding period is calculated
• The specific time thresholds applicable to different asset classes
• The tax implications of each category

What is a Capital Asset?

The capital asset definition under section 2(14) of the Income-tax Act 1961 needs to be established before the assessment of short-term and long-term capital gain differences can begin. The capital asset definition includes all types of property which a person or business entity possesses even if the property does not serve their work-related activities.

This definition of capital assets is quite broad and includes various forms of investments and valuable assets.

The following are examples of capital assets:

• Immovable Property: Land, Buildings, Residential Homes and Commercial Buildings
• Shares and Securities: Listed Shares, Unlisted Shares, Bonds, Debentures
• Mutual Fund Units: Equity Mutual Funds and Debt Mutual Funds
• Jewellery
• Investment in Capital Partnership
• Zero Coupon Bonds

Understanding the Holding Period

The process of classifying a capital asset begins with its identification as a capital asset through the assessment of its holding duration which needs to be established for determining whether the resulting gain will be classified as short-term or long-term. The holding period defines the time duration which the tax payer maintains ownership of a capital asset before selling it.

The holding period refers to the duration between two key dates, the date on which the asset is acquired and the date on which it is transferred (sold). It begins on the date of acquisition and ends on the date ownership is transferred.

The Income-tax Act establishes two distinct time frames which serve as criteria for determining how short-term and long-term treatment will apply to an asset based on its transfer date and acquisition date.

The correct holding period calculation needs the following steps to be performed.

• The acquisition date marks the moment when you either bought or legally acquired the asset.
• The date of transfer marks the point when ownership of the asset gets transferred which usually happens on the day of sale.
• The Length of Time calculation requires you to find out how much time passed between the two key dates which are acquisition and transfer.
  

The tax assessment depends on precise calculations because a minor time difference can lead to different asset classifications which subsequently affect tax obligations.

Example 1: Listed Shares

• Purchase date: 1 January 2023
• Sale date: 10 February 2024

Holding period: 13 months and 10 days

Since listed equity shares have a 12-month threshold (explained in the next section), this would qualify as a long-term capital asset.

Example 2: Immovable Property

• Purchase date: 1 January 2021
• Sale date: 15 January 2023

Holding period: 24 months and 15 days

As immovable property has a 24-month threshold, this would qualify as a long-term capital asset.

Short-Term Capital Gains

Any increase in the value of a security or piece of property due to a sale or transfer of ownership within a certain amount of time before the sale or transfer occurs can be classified as short-term capital gain.

The time frame, or holding period, is independent of any other factor and will vary between assets. It is, therefore, imperative that you identify the correct holding period rule applicable to your asset.

General Rule: Holding Period Of 36 Months

In general, if the capital asset has a holding period of 36 months or less and is sold or transferred, the capital gain would be considered to be a short-term capital gain. This is provided you have held the assets up to their respective holding periods before the asset is sold or otherwise transferred. This rule will generally apply unless there is a specific exception provided for the particular asset.

Exception One: Twelve-Month Holding Period

The standard 24-month holding period for these financial assets will be shortened to a 12-month duration.

The following assets held for 12 months or less will be treated as short-term capital assets:

• Equity shares which trade on Indian stock exchanges

• Equity-oriented mutual fund units

• UTI unit holdings

• Zero-coupon bonds

The assets according to this rule become long-term capital assets after they have been held for over 12 months.

Exception Two: Twenty-Four Month Holding Period

The holding period for certain asset types comes with a reduced requirement which establishes 24 months as the new minimum duration.

The following assets will withstand the 24-month holding period limitation if they have been held for 24 months or less and will be treated as short-term capital assets:

• Shares in an unlisted company and

• Land or building (or both).

All assets which remain under ownership for more than 24 months will be classified as long-term capital assets.

Practical Example

Example 1: Listed Shares

You buy listed shares on April 1 2024 and you sell them on March 30 2025. You have held the shares for less than 12 months and your gain will be classified as a short-term capital gain.

Example 2: Property

You buy a flat on January 1 2023 and you sell that flat on December 1 2024. You have held the flat for less than 24 months and your gain will be classified as a short-term capital gain.

Long-Term Capital Gains (LTCG)

A Long-Term Capital Gain (LTCG) will occur if an individual has held onto an asset for longer than the specified period before selling.

Tangible assets owned beyond the shorter holding time frames of listed stocks (12 months); listed equity mutual funds (12 months); unlisted stocks (24 months); all other capital assets (36 months), are considered long term capital assets. Gains from long term capital sales will also be taxed as long-term capital gains.

LTCG holding period thresholds are as follows:

• Listed equities, equity-oriented mutual funds and UTI units, as well as zero-coupon bonds must be held for over 12 months;
• Unlisted equities, land, and buildings must be held for over 24 months; and
• All other capital assets must be held for over 36 months unless otherwise specified by the holding period threshold.
  

Some examples include:

• Listed equities that are sold after being held for 13 months will result in LTCG;
• Real estate that is sold after being held for 25 months will result in LTCG; and
• Unlisted equities that are sold after being held for 30 months will result in LTCG.
  

Long-term capital gains (LTCG) are generally subject to less tax than short-term capital gains (STCG). Some ways that LTCG can be taxed at less of a tax rate are shown below:

• LTCG can be taxed at reduced tax rates. Some types of LTCG will be taxed at reduced tax rate, whereas STCG will be taxed as per the slab rates for STCG;
• Certain capital assets (such as real estate) may have the option of using indexation;
• If you have held Listed Equity Shares for over 12 months and sell them afterwards, you will recognize a Long Term Capital Gain (LTCG) under certain rules, and the LTCGs will be taxed at a lower or concessional rate (within certain limits).
  

When you sell a piece of Real Estate that you have owned for more than 24 months prior to the sale, you will recognize a LTCG. The Taxpayer can:

• Apply Indexation to Revalue Basis of Property
• Claim Exemption Under 54 (If Certain Criteria are Met)
  

Tax Rates: STCG vs LTCG

The first step in tax assessment begins after investors designate their capital gains as either short-term or long-term. The tax rate depends on two factors which include the asset's holding duration and its specific asset classification.

Different provisions of the Income-tax Act, such as Section 111A, Section 112, and Section 112A govern the taxation of capital gains.

1. Tax on Short-Term Capital Gains (STCG)

a) Listed Equity Shares & Equity-Oriented Mutual Funds

Short-term capital gains become taxable under Section 111A at a special rate which applies after taxpayers pay securities transaction tax (STT) together with the required surcharge and cess.

b) other assets (e.g. real estate, unlisted equity, debt investments, etc.) — the short-term capital gains resulting from a sale or transfer of these types of other assets would be included in your total income and taxed in accordance with the taxpayer's applicable ordinary income tax bracket — i.e. generally the same as capital gains from other types of assets.

Your income bracket establishes which tax rate applies to your situation.

2. Tax on Long-Term Capital Gains (LTCG)

a) Listed Equity Shares & Equity-Oriented Mutual Funds

Long-term capital gains become taxable under Section 112A at a reduced rate which taxpayers must meet a specific exemption threshold. Taxpayers must pay tax on all gains which exceed the established threshold.

b) Immovable Property & Unlisted Shares

Taxation for long-term gains follows Section 112 which establishes a fixed tax rate while taxpayers can use indexation advantages according to current legislation.

c) Debt Mutual Funds & Other Assets

The tax treatment relies on existing legislative requirements and the type of asset involved.

Indexation Benefit Explained

This article discusses the indexation benefit, which is an important factor that is available to some people in regard to long-term assets. Indexing reduces the tax you owe by adjusting the asset's original purchase price for the increases in price due to inflation.

What is Indexation?

The function of indexation is to enable taxpayers to adjust the purchase price of their property to allow for increases in the price level since it was purchased. The adjusted purchase price (or adjusted, indexed cost) is what you will pay the tax authority on.

As the real value of money decreases because inflation has increased, you are taxed only on the increase in value, not on all of the increases.

Cost Inflation Index (CII)

At the beginning of each financial year, the Government of India publishes the CII. The CII indicates the inflation rate for the previous financial year and will be used to calculate your indexed cost.

Formula for calculating the Cost of Acquisition

Indexed cost = (Cost of Acquisition x CII of the year transferred) ÷ CII of the year acquired

Evaluating the Asset

The indexation benefit is applicable only to the following types of assets:

• Immovable property
• Long-term capital assets subject to Taxation in terms of the Tax Law as per Section 112
  

The indexation benefit is not applicable to long-term capital gains in regard to both listed equity shares and mutual funds that are capitalised under Section 112A.

SPECIAL SITUATIONS - Holding Period (Gift, Inheritance, etc.)

A capital asset may sometimes be acquired by a taxpayer not through direct purchase but instead through means such as:

• Gift
• Inheritance
• Succession
• Partition of a HUF (Hindu Undivided Family)
• Will
• Certain specified transfers
  

These types of acquisitions typically require the application of special rules to determine the holding period.

These special rules are contained in Section 49(1) and the Explanation to Section 2(42A) of the Income Tax Act.

Inclusion of Prior Owner’s Holding Period

The prior owner’s holding period will also count toward the total holding period of a capital asset when the capital asset is acquired through:

• Gift
• Will
• Inheritance
• Succession
• Partition of an HUF
• Certain specified transfers
  

In other words, the taxpayer does not start counting their holding period from the date they receive the asset, but rather they start counting their holding period from the date on which the prior owner originally purchased the capital asset.

How to Calculate in These Circumstances

To determine if a capital asset is short-term or long-term when it was acquired, the following must be determined:

• Previous owner's acquisition date
• Transfer of the asset from the previous to the current owner
• Date of sale during which the current owner sold the capital asset
  

The total holding period is then calculated by adding together the length of all the above periods of time.

Capital Gains Exemptions Under the Income Tax Act

Long-term capital gains (LTCG) have the added benefit of being eligible for a number of different exemptions from taxation as outlined under the Income Tax Act. If certain criteria are established, the tax liability on capital gains can be greatly diminished or even eliminated completely.

Most exemptions apply solely to long-term capital gains; therefore, it is imperative to proper categorize the type of gain.

Section 54 – Exemption on the Sale of a Residential Property When:

The long-term residential house property is sold.

Condition: In order to qualify for the exemption, the capital gain must be reinvested to purchase or build another residential house property in India.

Time frames for Exemption: If the property is purchased, it must be purchased:

1. Within one year before selling the property;

2. Within two years after selling the property; or

If the property is constructed, it must be built within three years after selling the property.

Lock-in Period: Once the new property has been purchased or constructed, it cannot be sold for a period not less than three years (subject to current regulations). If the entire capital gain is reinvested, then the entire capital gain would be exempt.

Section 54F – Sale of Other Long-Term Capital Assets

When: Another long-term capital asset (other than a residential house) is disposed.

Condition: The entire net sale proceeds from the sale of the long-term capital asset must be used to buy or build one residential house in India.

The taxpayer must not own or have an interest in more than one residential house before disposing of the long-term capital asset other than the long-term capital asset being disposed of.

Set-Off and Carry Forward Rules for Capital Losses

When the Income Tax Act addresses capital gains, it also covers relief through the allowable adjustment of capital loss against other gains. As such, one of the areas in tax planning has to do with how you will adjust capital losses against capital gains.

Capital losses are classified like capital gains:

1. Short-Term Capital Loss (STCL)

2. Long-Term Capital Loss (LTCL)

Capital loss adjustment rules vary based on their classification.

1) Intra-Head Capital Loss Transfer Rules:

a) Capital losses can only be used to offset capital gains (i.e. they can only be applied against the same head of income).

The adjustment of capital losses and capital gains is done as follows:

• STCL: Can only be used to offset STCG AND LTCG
• LTCL: Can only be used to offset LTCG
• LTCL cannot be used to offset STCG.
  

For example, assume you have made the following transactions in a financial year:

• STCG - ₹ 2,00,000
• LTCG - ₹ 3,00,000
• STCL - ₹ 1,50,000
• LTCL - ₹ 1,00,000
  

Adjustments to the gains will be as follows:

• STCL of ₹ 1,50,000 can offset either STCG or LTCG.
• LTCL of ₹ 1,00,000 will only be able to offset LTCG.

Thus, your total taxable gains will be reduced.

2. Carrying Forward Capital Losses

Capital losses which could not be fully offset in a financial year can be carried forward.

Basic Rules:

• Capital losses can be carried forward for a maximum of 8 years of assessment.
• Losses can be carried forward only if the taxpayer has filed an income tax return before the due date in terms of TAX ACT section 139 (1).

Subsequent years:

• Short-term Capital Losses can be used in future years to offset either short-term or long-term capital gains.
• Long-term Capital Losses can only be used to offset long-term capital gains.
  

Recent Amendments and Appropriation Changes Affecting Capital Gains

The taxation of capital gains has changed a lot over the last few years. Because tax law changes through Finance acts and Union budgets, investors will need to keep current with the latest changes before making a sale.

The following are some major areas where amendments have had a significant impact on the taxation of capital gains.

1. Taxation of Debt Mutual Funds

The major change is how long-term capital gains on certain debt mutual funds are taxed.

Previously, long-term capital gains earned from certain types of debt mutual funds qualified for indexation benefits if the mutual fund was held for a specified length of time. However, amendments to the tax law have changed these rules for any investments made after a certain date.

Most long-term capital gains from certain types of debt mutual funds are now subject to slab tax rates regardless of how long they were held; therefore, indexation was not used making the debt mutual funds less tax-efficient.

So, if you invested on a certain date, you should check to see how these rules apply to your investment.

2. Long-Term Capital Gains on Listed Equity (Section 112A)

The long-term capital gains on listed equity shares and equity-oriented mutual funds will continue to be taxed at a concessional rate until they exceed a certain level as determined by Section 112A.

The purpose of introducing this section was to limit the taxation of long-term capital gains on equities to no greater than a specific amount

Conclusion

Knowing the difference between short and long-term capital gain is important for tax planning and maximizing your return after taxes. It is based on how long the asset is held by you and directly affects:

• The tax rate that applies
• Whether indexation will apply
• If any exemptions will apply
• Whether you can offset losses against short or long-term gains
  

The different tax rates for various asset types result in different tax outcomes from even minor changes in the timing of asset acquisition and asset transfer. The creation of accurate records which show the exact dates of asset acquisition and asset sale, together with knowledge of current tax regulations and proper transaction scheduling, will help you achieve legal compliance while maximizing your financial results. Book a Free Tax assessment call with us today!

Frequently Asked Questions

1. Are capital gains added to my total income?

It depends on the type. Certain STCG (other than those under Section 111A) are added to total income and taxed as per slab rates. While some LTCG are taxed at special rates separately from slab income.

2. How is capital gain calculated?

Capital Gain = Sale Consideration – (Cost of Acquisition + Cost of Improvement + Transfer Expenses)

For eligible long-term assets, indexed cost may be substituted instead of actual cost.

3. What documents should I keep for capital gains calculation?

You should retain:

• Purchase deed or contract note
• Sale deed or broker statement
• Improvement cost invoices
• Brokerage or transfer expense proof
• CII reference for indexation