How to Calculate Capital Gains

What are Capital Gains?

Capital gains arise when you sell capital asset for an amount that is more than what you paid for it.
Capital assets are any investment products like mutual funds, stocks or any real estate product like
land, house etc. An increase in the value of any of these when you sell them is termed as capital gain.
Similarly, a capital loss is suffered in case there is a decrease in the value of an asset with respect to
its purchase price.

A realized capital gain occurs only when you actually sell the asset at a higher price than its original
purchase price.

Types of Capital Gains:

Capital gains can broadly be classified into two types:

Long-Term Capital Gains:Depending upon the type of asset, if it is held for more than 36 months it is
termed as long-term capital asset and the gain on selling it is termed as long-term capital gains. For
mutual funds and equities, this period is 12 months.Short-Term Capital Gains: Any asset that is sold
within 36 months of purchasing it, is termed as short-term asset and the gain on selling the same is
termed as short-term capital gain.

Tax on Capital Gains:

Calculation of tax is dependent upon the type of capital gain.

Calculation of tax on short-term capital gains is simpler than that on long-term gains. For short-term
gains, the gain is added to the total income and then the income tax is calculated based on the tax
bracket that you fall in.Calculation of tax on long-term capital gains is a slightly trickier business.
Since long-term capital assets are held for longer periods, inflation also factors in while computing tax
on long-term capital gains.

Cost Inflation Index (CII):

Cost inflation Index is a term that comes into play when we talk about long-term capital gains. This
index is fixed and is declared every year by the government. For calculating capital gains on longterm assets, indexation is used.

What is indexation?

Indexation is the process of adjusting prices based on a standard index so as to factor in the inflation
rate also while calculating profits earned on sale of assets. Indexation is important because prices
generally do not remain flat and tend to vary with time; hence, computing profits based on the original
price of an asset is not an accurate measure of profit. Indexation takes into account inflation too and
gives us a more reasonable figure for long-term capital gains.

Example of Taxation On Long-Term Capital Gains (Real Estate):

Using Indexation:

Mr. Mishra bought a plot of land for Rs.10,00,000 in the year 2005. After 10 years had elapsed, in
January 2015, he sold off his land for Rs.30,00,000.

Cost Inflation Index, CII= Index for financial year 2014-15/Index for financial year 2005-2006 =
1024/480 = 2.13

Indexed cost of purchase = CII x Purchase Price = 2.13 x 10,00,000 = 21,30,000

Long-term capital gain = Selling Price Indexed cost = 30,00,000 21,30,000 = Rs.8,70,000

Tax on capital gain = 20% of 8,70,000 = 1,74,000

Tax on capital gains without Indexation (for stocks and mutual funds):

There is an option of not going the complicated route of indexation and directly computing capital
gain tax. In this case, only 10% of the non-indexed capital gain is charged as tax. Individuals are free
to choose to use indexation and pay 20% tax or ignore indexation and pay 10% on their capital gains.
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Government provides a number of exemptions which can be claimed on capital profits made. Here is
a list of all the exemptions that can be claimed with respect to gains from capital assets.

Section 54 of the Income Tax Act entitles a person to tax exemption on profit earned if that entire
profit amount is used to buy another house. The seller can buy a new house within 2 years from the
date of sale of his previous property or construct a new house within 3 years from the date of
sale.Section 54 EC entitles an individual for tax exemption if the entire capital profit is invested in
bonds issued by NHAI that is National Highway Authority of India or REC which is Rural
Electrification Corporation. There is a limit to exemption under 54 EC and is Rs.50 lakh.In case you
cant find the right property to buy and you are unable to come up with a concrete plan in 2-3 years,
you still can save tax on the capital profit earned. This can be achieved by investing gains in the
Capital Gains Accounts Scheme (CGAS) in any public sector bank. This amount can then be claimed
for tax exemption. However, you are required to invest this money within the period stated by the
bank else the deposit is treated as capital gain and tax is deducted on it.In case you sell an agricultural
land which is not within the limits of a civic body then tax is not levied on capital gain arising out of
it.Capital gains is not applicable to sale of property if the entire amount is invested to set up a small
scale or a medium scale industry. However, to avail tax exemption, the tools and machinery for
manufacturing should be bought within 6 months from date of sale.
Example

Rahul bought 10 acres of land at Rs. 3 lakhs per acre on 30th Jan, 2000. He paid 30 lakhs for the
property.
Case 1: He sold the property on 30th Apr, 2002 at the rate of Rs 4 lakhs per acre. This means he sold it
at Rs 40 lakhs and before 3 years. Hence, short term capital gains will be applicable. In this case, there
will be no indexation benefit and Rahul will have to pay tax on the gain which is 10 lakhs (40 lakhs
30 lakhs). The gain of 10 lakhs will be added to his regular income and will be taxed as per the tax
slab he falls into.
Case 2: He sold the property on 10th Jan, 2004 at the rate of 4.2 lakhs per acre. This means he
received Rs 42 lakhs. Moreover, since this is done after 3 years, the gain will be taxed by factoring
indexation. Hence the investor will not pay tax on Rs 12 lakhs (Rs 42 lakhs Rs 30 lakhs) but an
amount lesser than 12 lakhs.
In this case, lets take a look at the CII numbers. Numbers for other years which are not relevant to us
have been skipped.
Now to calculate long term capital gain, the acquisition price will not be taken as Rs 30 lakhs, a new
figure will be considered, this is also known as indexed cost of acquisition, which factors in CII.
The new price of acquisition = Initial price * (CII for the year sold / CII for the year bought)
This will give 30 lakhs * (463 / 389) = 35.71 lakhs.
The capital gainwill be Rs 42 lakhs Rs 35.71 lakhs = 6.29 lakhs. This is the amount on which the
investor has to pay taxes at the rate of 20%. This means the investor will have to pay an amount of
20% of 6.29 lakhs = 1.25 lakhs.
Example
Of Rahul is nice.
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