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Capital Assets, Capital Gains And Capital Gains Tax

This is a brief overview of various provisions with regards to sale of Capital Assets and taxation of the Capital Gains thereof i.e. the profits made during such sale.

1. What is Capital Gains?
When you sell or transfer any Capital Asset and make a profit on the same, such profits are termed as Capital Gains. By the way, inherited Capital Asset is not considered as a transfer for taxation purposes.

2. What are Capital Assets?
Any movable or immovable property that you own, is classified as a Capital Asset.

Some of the common Capital Assets that people normally own include land, house, building, shares, mutual funds, bonds, debentures, vehicles, jewellery, paintings etc. Even patents and trademarks come under the purview of Capital Assets.

The exceptions i.e. items which are NOT classified as Capital Assets are stock-in-trade or raw material for business or profession, things for personal use (e.g. car, TV, refrigerator, AC, furniture etc.), agricultural land (except land situated near urban areas as per specified rules), Gold Deposit Bonds etc.

3. How is the holding period important?
Since taxation of the capital gains depends on how long you have owned the property, holding period is quite important to minimize the tax liability. Accordingly, as per tax laws, you can either have short-term capital assets or long-term capital assets.

Short-term capital assets
a) Shares, equity-oriented mutual funds, and listed bonds, debentures, Govt. securities, etc. held for LESS THAN 12 months.
b) Immovable property held for LESS THAN 24 months
b) Other Capital Assets such as debt mutual funds held for LESS THAN 36 months.

capital-gains-tax
How can you protect your Capital Gains from Taxation.

Long-term capital assets
a) Shares, equity-oriented mutual funds, and listed bonds, debentures, Govt. securities, etc. held for MORE THAN 12 months.
b) Immovable property held for MORE THAN 24 months
b) All other Capital Assets such as debt mutual funds held for MORE THAN 36 months.

Note : For Capital Assets received as gift or inheritance, the holding period of the previous owner is to be included  with your own holding period  to determine if it is a short-term or long-term capital asset.

4. How are short-term and long-term capital gains calculated?
The main difference between short-term and long-term capital gains is that for long-term capital gains you are allowed the benefit of indexation (except in case of long term capital gains from shares and equity-oriented mutual funds).

So, Short Term Capital Gains = Sale Price - Cost Price - Expenses incurred for sale - Cost of improvement

And, Long Term Capital Gains = Sale Price - Indexed Cost Price - Expenses incurred for sale - Indexed Cost of improvement

5. What is Indexed Cost?
This is the benefit provided to suitably increase the Actual Cost Price by incorporating the impact of inflation. Hence, only the real gains are taxable and not the rise in asset price due to inflation. 

Indexed Cost = (Actual Cost Price * Cost Inflation Index in the year of sale) / Cost Inflation Index in the year of purchase

6. What are Expenses incurred for sale and Cost of improvement?
Expenses incurred for sale will usually include brokerage, commission fees etc. paid to transfer the asset, or the cost of stamp paper while selling the house. (STT or Securities Transaction Tax paid is NOT allowed as a deduction here.)

Cost of improvement will include the expenses you had incurred in improving the asset while it was under your ownership.

7. What are the tax exemptions allowed on capital gains?
There are NO tax exemptions on short-term capital gains.

However, you can save tax on long-term capital gains. In this regards, two common provisions are Sec 54 and Sec 54EC. 

You can save tax on long term capital gains from the sale of residential house by
a. Investing in another house property (Sec 54)
- Bought a new property within 1 year before or 2 years after the sale of old property
- Constructed a new property within 3 years after the sale of old property
- New property acquired should be owned for at least 3 years
- Only the Capital Gains need to be invested, not the entire sale proceeds

b. Investing in specified bonds (Sec 54EC)
- Issued by REC / NHAI / other bonds notified by the Govt.
- Within a period of 6 months from the date of sale
- Subject to a limit of Rs.50 lakhs (gains above Rs.50 lakhs will be taxable)
- Tenure of these bonds would be 5 years

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