Understanding Capital Gains Tax

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Capital Gain is defined as any profit or gain arising from the sale of capital asset such as land, apartment, commercial property etc (agricultural land is NOT considered as capital asset). Such gains are taxable under Indian Income Tax Act in the year of asset sale. The taxability of capital gains depends on the nature of gain, i.e. whether short-term or long-term. Hence, to determine the taxability, capital gains are classified into short-term capital gain (STCG) and long-term capital gain (LTCG). In other words, the tax rates for long-term capital gain and short-term capital gain are different.

Capital Asset

Short term capital assets are such capital assets that are held for less than 3 years. If the capital asset is held for more than 3 years it is considered as Long term capital asset. So how does one calculate the period of three years? Is it from the date of booking or the date of execution of sale deed? Though there are two views on this, IT department has consistently maintained that booking a property does not give you the right to property. Hence the three years period will be calculated from the date of registration of sale deed.

Calculating Capital Gain Tax

For example- let’s say you bought an apartment on April 2, 2010 (date of execution of sale deed) and sold it on August 10, 2012. As the period of holding the asset is less than 3 years it shall be considered as short term capital gain (STCG). This is added to your annual income and taxed according to your tax slab – 10%, 20% or 30%. Any improvement done to the property can be adjusted against the sale price of the property to calculate STCG.

STCG = SALE PRICE – (COST OF ACQUISITION + COST OF IMPROVEMENT)

However, if the property is sold on August 10, 2015 it shall be considered as long term capital gain (LTCG) and taxed at 20% after indexation.Any improvement done to the property can be adjusted against the sale price of the property to calculate LTCG.

LTCG = SALE PRICE – INDEXATION RATIO * (COST OF ACQUISITION + COST OF IMPROVEMENT)

INDEXATION RATIO = COST INFLATION INDEX (CII) OF YEAR OF SALE / COST INFLATION INDEX OF YEAR OF ACQUISITION

In the above example indexation ratio is = CII Year 2015 / CII Year 2010 = 1081/711 = 1.52

(CII data can be found here)

How to Save Tax on LTCG

Income Tax Act allows you to claim tax exemption on LTCG on the sale of property. To avail this tax exemption you must:

  1. use the gain to buy another house within two years of sale of first property
  2. use the gain to construct another house (if the property is not ready within 3 years proportionate amount paid can be used to claim tax exemption)
  3. set off the gain against a second house bought within a year before selling the first one
  4. In case you do not want to buy another property you can still claim tax exemption by investing LTCG amount in National Highways Authority of India or Rural Electrification Corporation Limited bonds of tenure 3 years within six months of selling the house. However, you can invest only up to 50 lakh in such bonds.
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