Anand Rathi Insights

Capital Gains

The Importance of asset allocation

Capital gains refer to the profit that an individual or entity makes from the sale of a capital asset, such as a stock, bond, real estate or mutual fund. These gains are subject to taxes, and the tax rate is determined by the holding period of the asset.

Types of Capital Gains:

There are two types of capital gains: short-term capital gains (STCG) and long-term capital gains (LTCG). Short-term capital gains are gains made from the sale of a capital asset that has been held for less than 36 months. These gains are taxed at the marginal tax rate of the individual. For example, if an individual is in the 30% tax bracket, STCG will be taxed at 30%.

Long-term capital gains, on the other hand, are gains made from the sale of a capital asset that has been held for more than 36 months. These gains are taxed at a lower rate of 20% with indexation benefit. Indexation is the process of adjusting the cost of acquisition and cost of improvement of the asset to account for inflation. This results in a lower tax liability as the indexed cost of acquisition is considered while calculating the capital gains.

Can an individual get tax deductions and exemption on capital gains?

There are certain exemptions and deductions available to individuals to reduce their capital gains tax liability. One such exemption is the capital gains tax exemption under Section 54 of the Income Tax Act. This section allows individuals to claim an exemption on capital gains tax on the sale of a residential property, provided they invest the sale proceeds in a new residential property within specified time limits.

Another way to reduce capital gains tax liability is by investing the capital gains in specified bonds under Section 54EC of the Income Tax Act. These bonds are issued by National Highways Authority of India (NHAI) and Rural Electrification Corporation Limited (REC) for a lock-in period of 3 years. The invested amount is eligible for tax exemption up to Rs 50 lakhs in a financial year.

Another way to reduce tax liability on capital gains is by investing in Equity-Linked Saving Schemes (ELSS) of mutual funds. ELSS schemes are eligible for tax benefits under Section 80C of the Income Tax Act, which means that investments up to Rs 1.5 lakh can be claimed as a deduction from the taxable income. Additionally, as ELSS schemes have a lock-in period of 3 years, it can help the investor to align their investments with long-term investment goals.

It's important for investors to keep accurate records of their capital gains and expenses related to the asset, such as brokerage fees, legal fees and stamp duty, as these expenses can be used to reduce the capital gains. Additionally, it's also important for investors to consult a tax advisor to understand the tax implications of their investments and to ensure that they are taking advantage of all the available tax exemptions and deductions.