When you start investing, it’s crucial to understand something called “capital gains tax.” It’s like having a silent partner on your financial journey. This partner comes into play when you make money by selling assets. But it’s more than just about paying taxes. Understanding capital gains tax helps you see how your profits and what the government expects from you are connected. It affects your investment decisions and how money moves around in our economy.

Let’s find out what capital gains tax means, why it should matter for your investments, and how you can calculate it. All these aspects will be covered in this blog.

What is Capital Gains Tax?

Capital gains tax is like a fee imposed by the government when you make money from selling valuable things like stocks or property. It’s a way for the government to take a small portion of your earnings. Whether you sell stocks or your old property, any profit you make from these sales could be taxed. This tax money is used for things like building roads and schools, impacting both your personal investment choices and the government’s plans for public projects.

Types of Capital Gains Tax

Let’s understand the type of capital gains tax from this table;

Long Term Capital Gains (LTCG)Short-Term Capital Gains (STCG)
DefinitionProfits on assets held for more than a year are considered under long-term capital gains tax.Short-term capital gains result from the sale of assets held for a shorter period than 1 year.
TaxationTaxed separately from short-term capital gains tax, usually at lower rates.Calculated at higher rates compared to LTCG and subjected to the individual’s applicable income tax slab.
ObjectivePromotes long-term thinking among investors to foster steady market conditions.Often leads to quick turnovers in investments, creating market volatility.
Tax RatesTypically lower tax rates, encouraging long-term investment strategies.Higher tax rates discourage short-term trading activities.
ExampleBuying and holding onto stocks for over a year before selling.Selling stocks within a year of purchase to capitalise on short-term market movements.

Tax rates for long-term and short-term capital gains differ based on the type of asset and duration of holding. Here’s a brief overview:

Understanding the Tax Rate

Below is an overview of the tax rates for long-term and short-term capital gains, based on the type of asset and duration of holding:

Long-Term Capital Gains: Taxes on gains from assets held for more than one year.

  1. The applicable tax would be 10% over and above ₹1 Lakh when the sale of:
    – Listed Equity shares only if STT has been paid on the purchase and sale of such shares
    – Equity oriented mutual fund units only If STT has been paid on the sale of such units
  2.  The applicable tax on other assets during the sale is 20%

Short-Term Capital Gains: Taxes on gains from assets held for less than one year. 

  1. The applicable tax would be based on normal income tax slab rates when securities transaction tax (STT) is not applicable.
  2. The Applicable tax would be 15% when the STT is applicable.

How to calculate Capital Gains?

When an asset is sold, capital gains arise when the purchasing price gets deducted from the selling price. After doing this calculation, it will be evident how much has been realised in the sale and whether it should be taxed or not, depending on factors like holding period and governing tax rates.

For example, let us say you bought a share for ₹1,000 and sold it at ₹1,500. The purchase cost was ₹1,000 while the sale price happens to be ₹1,500. Gain equals to difference between cost price and sale proceeds i.e., ₹500.

How to calculate Long-term capital gains?

Long-Term Capital Gains

Just follow these simple steps to calculate your long-term capital gain:

  • Identify the Asset: Choose any asset you want to compute your long-term capital gain
  • Determine Acquisition Cost: This constitutes the purchase price plus any expenses incurred while acquiring it
  • Add Adjustments: This step, alternatively known as Indexation, enhances costs of acquisition by accounting for changes in the Consumer Price Index (CPI), hence reducing LTCG liability
  • Calculate Selling Price: The sales proceeds are what make revenue resulting from the disposal of sales items
  • Compute Capital Gains: Subtracting the sale price (after indexing) from the buying cost gives capital gains made
  • Apply LTCG Tax Rate: There is a prescribed taxation rate for long-term capital gains set by the Government
  • Final Tax Liability Calculation: Finally, knowing the amount of LTCG and applying the tax rate in accordance with the law will help determine the final tax liability

By following these steps, you can correctly calculate their long term capital gains and pay taxes as per applicable provisions of the law.

How to Calculate Short-Term Capital Gains

Calculating short term capital gains follows a similar process to long term capital gains, except that it has a shorter holding period. Capital gains would also have to be calculated by subtracting the acquisition cost from the selling price and any other expenses made during the purchase if they were long-term.

Deductible Expenses on sales of shares 

Deductible expenditures on the sale of shares are charges paid by investors, that are subtracted from total sale proceeds to calculate taxable capital gain. Such costs typically include brokerage fees, transaction charges or any other directly related expenses incurred when selling shares. These deductions help reduce overall capital gain that becomes subject to tax thus reducing investor’s tax liability. 

For investors to be able to calculate their taxes accurately and comply with revenue regulations, they must keep records of these deductible expenditures.

Conclusion

It’s essential to anyone who invests in stocks or real estate to understand capital gains tax since it influences decision-making and how much money you get to keep after your investments. This article clarified what capital gains tax is, why it matters, and how it operates.

FAQs

What exemptions or deductions can help reduce my capital gains tax liability?

Some exclusions and deductions may reduce your Capital Gains Tax responsibilities when transferring ownership for sale reasons. For example, indexation, leveraging exemptions under the Income Tax Act and strategic tax planning, like timing asset sales to align with lower tax rates or offsetting gains with losses from other investments, to reduce the tax burden.

How does the duration of holding an asset affect its taxation?

Normally, holdings that exceed one year will lead to lower taxes on long term profit earnings, including potential indexation benefits, while those less than 1 year may give rise to higher taxes on short term profit earnings according to the income slabs.

Can I offset capital losses against capital gains tax liabilities?

Yes, you can offset capital losses against capital gains tax liabilities through a strategy called tax loss harvesting. This involves off-setting investment losses with taxed gains thereby potentially reducing your total tax obligations.