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What is capital gains tax, and how it works?

The economy of India is still expanding. Therefore, it needs ongoing capital infusions to keep booming. Investors are key drivers of India's economic growth, making the capital gains tax an essential tool for asset purchases and sales.

  • 3,642 Views | Updated on: Mar 20, 2024

The word “capital gain” describes the increase in a capital asset’s value upon sale. A capital gain happens, to put it simply, when you sell an asset for more money than you purchased for it. Almost any kind of asset you own is a capital asset, whether it was bought for personal use or as an investment.

When you sell an asset, you realize capital gains by deducting the purchase price from the sale price. In certain situations, the Internal Revenue Service (IRS) taxes individuals on capital gains.

Understanding capital gains

The capital gains, or profits, are said to have been “realized” when stock shares or any other taxable investment assets are sold. Unsold investments and “unrealized capital gains” are exempt from the tax. No matter how long they are held or how much their value rises, stock shares will not be taxed until they are sold.

Most taxpayers pay a greater rate on their income than any potential long-term capital gains. Thus, they have a financial incentive to hang onto investments for at least a year to benefit from the lower profit tax.

Calculating Long-Term Capital Gains Tax

The steps involved in determining long-term capital gains are listed below

  • The person must first determine the asset’s total value.
  • The person then needs to deduct the following:
  • The costs associated with the transfer
  • Spending on purchases
  • Investments in improvements


To calculate the long-term capital gains tax, complete the aforementioned stages and then deduct any applicable exemptions granted by the following sections.

  • Section 54B
  • Section 54F
  • Section 54EC
  • Section 54

Calculating Short-Term Capital Gains Tax

Follow the steps listed below to calculate their short-term capital gains tax with accuracy:

  • Take into account the entire value of the item.
  • The points indicated below must then be deducted after that
  • Expenditures made to upgrade the property
  • All of the funds used to purchase the property
  • Costs related to the property’s sale or exchange
  • The remaining amount is the short-term capital gain after the deduction

Deductions to Reduce Capital Gains Tax

By utilising provisions under the following parts of the Income Tax Act, you may be able to reduce your capital gains tax obligation if you own an asset.

Section 54

If the money is then used to purchase another residential property, the capital gains on the sale of the residential real estate are not subject to taxation. However, this is subject to the following conditions being satisfied:

  • Real estate purchases should only be made two years or, at most, a year after they have been sold.
  • The transfer shall occur no later than three years from the initial property transfer date if the property is still being built.
  • The freshly acquired property is not transferrable for the first three years following acquisition or development.
  • The recently acquired property should have a location in India.

Section 54F

If you sell any other item, such as rare artwork, jewelry, loans of money, or agricultural property within ten kilometres of your city, you may be able to benefit from Section 54F. This provision permits a deduction from the proceeds of the liquidation of any financial instrument to finance the purchase of a residence or other residential property.

Section 54EC

Over ₹50 lakh in profits from bonds issued by the Rural Electrification Corporation (REC) or the National Highways Authority of India (NHAI) are exempt from capital gains tax. They have a 5-year term and a fixed interest rate (currently 5.25%). The interest rate on these bonds is taxable. Your investment must have generated a profit from selling real estate and other buildings for it to be eligible for this write-off.

Conclusion

Investors with taxable accounts must comprehend the capital gains tax, how it is computed, and the distinction between long-term and short-term capital gains. Investors will have a greater chance of keeping more of their earnings if they know the various tax rates and structures that apply to capital gains.

Key takeaways

  • Taxes on capital gains are only owed when an investment is sold.
  • Only “capital assets”—stocks, bonds, digital assets like cryptocurrencies and NFTs, jewelry, coin collections, and real estate—are subject to capital gains taxes.
  • Profits from investments held for longer than a year are subject to long-term gains tax.
  • Short-term gains are subject to the same taxation as an individual’s regular income. That is more than the tax on long-term gains for everyone but the wealthiest.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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